Earnings Call: Q3 2019

Nov 6, 2019

Good afternoon. My name is Lindsey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Killam Apartment REIT Third Quarter 2019 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. Mr. Philip Fraser, President and CEO, you may begin your conference. Thank you. Hello and thank you for joining Killam Apartment REIT's Q3 2019 conference call. I am here today with Robert Richardson, Executive Vice President Dale Noseworthy, Chief Financial Officer Aaron Cleveland, Vice President of Finance and Nancy Alexander, Senior Director of Investor Relations. 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 statement. Thanks, Phil. This presentation contains forward looking statements with respect to Killam Apartment REIT's operations, strategies, financial performance and conditions. The actual results and performance of Killam Apartment REIT could differ materially from those expressed or implied in such statements. These statements are qualified in their entirety by the inherent risks and uncertainties surrounding future expectations. Important factors that could cause actual results to differ materially from those expressed include, among other things, general economic and market factors, competition, changes in government regulations and factors described in the Risk Factors section of Killam's annual information form and other securities and regulatory filings. This cautionary statement qualifies all forward looking statements attributable to Killam and the persons acting on its behalf. Unless otherwise stated, all forward looking statements are as of the date of this presentation, and the parties have no obligation to update such statements. Thank you, Nancy. I am pleased to report another very strong quarter for Killam. We achieved net income of $46,800,000 compared to $27,100,000 in Q3 2018 and earned funds from operations of $0.27 per unit, a 3.8% increase from Q3 in 2018. We are focused on our strategic priorities and continue to execute on our targets for the year as summarized on Slide 4. Performance from our same property assets has been strong and we are on track to meet our same property NOI growth target. We have completed $149,000,000 of acquisitions so far this year, growing the portfolio to $3,100,000,000 We will meet our 2019 target to earn at least 30% of our 2019 NOI from outside Atlantic Canada. Our development plans are on track including the K in Mississauga which is now officially underway. And we are maintaining a strong balance sheet with conservative debt metrics. On Monday, we completed a $100,000,000 equity raise. This raise sets us up for continued growth in the year ahead. Approximately half the funds raised have already been applied to our line of credit and the remainder is expected to be used to fund acquisitions and developments. Following the close of this equity raise, our debt levels have improved by approximately 110 basis points down to 46% and our acquisition capacity has increased to approximately 300,000,000 I will now ask Dale to recap our financial results. Thanks, Bill. Slide 5 highlights our Q3 and year to date financial results. Killam generated FFO per unit of $0.27 3.8 percent higher than Q3 2018. Year to date, we generated $0.73 in FFO per unit, up 2.8% from last year. This growth is attributable to accretive acquisitions and developments and solid performance from our existing portfolio. Same property revenue and NOI growth were both strong in the quarter. The trend of high occupancy and rental rate growth continues as illustrated on Slide 6. Rents were up 3.4% in Q3, 90 basis points ahead of a year ago and our highest average rental rate increase in 7 years. Strong fundamentals paired with our revenue enhancing programs are driving higher rents, improved occupancy and low incentive offerings. We remain focused on expense management. As shown in slide 7, same property operating expenses were up 2.1% in Q3. Energy consumption savings realized from LED lighting retrofits Property taxes were also up increasing 2.5% quarter over quarter due to rising property assessments. In total, Killam's same property NOI margin increased by a healthy 60 basis points in the quarter and 40 basis points year to date. We continue to manage our balance sheet conservatively as highlighted on Slide 8. Debt as a percentage of total assets was 47.2% at the end of the quarter. Following the close of the recent equity raise and the subsequent repayment of the balance outstanding on our line of credit, our debt metrics have improved, which are expected to be seen with our Q4 results. In addition to a stronger balance sheet, Killam's acquisition capacity has increased substantially. Slide 9 highlights our debt maturity profile, including average apartment mortgage rates by year versus CMHC insured rates. Based on current market conditions, we expect to refinance maturing debt throughout the remainder of this year and over the next 3 years at relatively flat rates. As shown on slide 10, Killam's real estate portfolio has grown to $3,100,000,000 in value. We are acquiring and developing new high quality assets in prime locations and investing in value enhancing capital upgrades at our existing assets. Same property NOI growth has contributed to fair value gains across the portfolio. In addition, we have continued to see cap rate compression this year, including a 16 basis point tightening in our apartment portfolio and 113 point compression in the MHC portfolio. Year to date, we've recognized $134,000,000 in fair value gains including $36,000,000 in Q3. A highlight this past quarter was cap rate compression in the Halifax market. We've seen an increase in the amount of demand for apartment product in Halifax from both local and institutional investors. CBRE highlighted this cap rate compression in its Q3 report. The 2nd quarter in a row, they've highlighted valuation increase in the Halifax market. Investors are attracted to the city's solid apartment fundamentals, including strong population growth, rising rents and low vacancy. I'll now turn the call over to Robert, who will provide details on our operating performance this quarter. Thank you, Dale. Good afternoon, everyone. As shown on Slide 11, Killam continues to execute its strategy of increasing unitholder value. Specifically, we continue to focus on increasing funds from operations and net asset value based on 3 strategic priorities. 1, increase Killam's earnings from its existing portfolio 2, expand the portfolio, diversifying geographically through accretive acquisitions with an emphasis on newer properties and 3, since 2010, Killam has developed high quality properties in Killam's core markets. I will focus on Killam's operating performance year to date and detail a number of key revenue and expense management initiatives before turning the call back to Philip to discuss our year to date acquisitions and development progress. Killam's existing portfolio of 16,000 apartment units, 5,400 MHC sites, plus 750,000 square feet of commercial space is focused on maximizing unitholder value. Our strong same property NOI performance in 2018 and year to date 2019 is largely attributable to our ability to grow revenues. Slide 12 charts the rental rate trends over the past 3 years. We have generated consistent revenue growth each quarter for the past 7 quarters as we execute Killam's revenue enhancing programs. For Q3 2019, we delivered overall same property rental rate growth of 3.4%, a 90 basis point increase versus Q3 2018. Broken down, renewing tenants, which annually represents plus or minus 70% of our apartment portfolio, delivered an average gain of 2.1%, up 40 basis points over Q3 2018. However, Killam's best rental return is with units rented to new tenants on turnover. This quarter, Killam delivered 5.7 percent rental growth on new leasing, a 70 basis point improvement versus the same period in 2018. Please refer to Slide 13. Killam's value proposition and market conditions have never been stronger. As we experienced record occupancy levels in many of Killam's core markets, we have seized the opportunity to optimize rents as units turn by executing on 2 key strategies. First, 78 percent of Killam's apartment units are open market, meaning Killam can bring rents to market at renewal time instead of exclusively when a unit becomes vacant, as is the case in Ontario, for example. And secondly, this year, we will invest between $7,000,000 $1,000,000 $8,000,000 to renovate and upgrade select units to generate on average an all cash return of 13%. Market demand for Killam's new and newly renovated rental units is healthy across the portfolio and in response, Killam has accelerated its suite repositioning program. For 2019, we will deliver 300 plus repositioned units that should generate an aggregate $1,000,000 in additional net operating income. With 250 suite renovations completed, we are executing to plan. So far in 2019, the average monthly rental increase for a reposition unit was $280 generating an unlevered return of 13% on an average investment of $26,000 Given these metrics, Killam plans to increase its unit repositioning program to complete 400 to 500 units in 2020. We expect this to improve our top line annualized revenue by approximately $1,500,000 Unit enhancing upgrades deliver outstanding returns, and this reality is not restricted to specific geographies or properties, but it's virtually universal across Kilometers portfolio when we upgrade any unit older than 10 years. Kiln has identified approximately 3,000 additional units for repositioning. Once these are completed, we expect to earn an estimated $10,000,000 in additional annualized rental revenue, representing an approximate $195,000,000 increase in net asset value. The average cost to reposition a unit is approximately $25,000 or $75,000,000 for these 3,000 units. I'd also want to highlight that once these 3,000 units outlined here are completed, the cycle starts again on a portion of the remaining 13,000 units in our portfolio that will by then have reached their tenure threshold. The cycle is continuous. As in past quarters, I will quickly profile 1 kiln's properties undergoing a renaissance. Please turn to Slide 14. Fort Howe in St. John, New Brunswick has commanding views overlooking the St. John Harbor. It was constructed 50 years ago and is still one of the largest apartment buildings in New Brunswick with 153 units. This mid rise property is being upgraded with new cladding, a new heating system and most importantly, newly renovated units. At Fort Howe, Killam on average invests $36,000 per unit to upgrade kitchens, bathrooms and flooring and generates $3.90 or 41 percent more rent per month, overall a 13% all cash return on investment. In conjunction with driving revenue growth, Killam is actively managing expenses to optimize net operating income. Killam is executing its 5 year $25,000,000 energy efficiency plan focused on energy savings, such as installation of ultra low flow toilets, LED lighting retrofits and heating system upgrades. These projects help to lessen Killam's carbon footprint and mitigate the impact of expense increases from rising energy rates and other inflationary pressures. This year, we are on target to complete $5,000,000 in projects having an average 5.6 year payback or an 18% return. For the past 4 years, Killam has attracted its portfolio's energy intensity on an expense per square foot basis along with its carbon dioxide emissions. As Slide 15 details, we are now tracking I'm sorry, taking monitoring further by working with a 3% with a 3rd party supplier to complete a full baseline audit of our greenhouse gas emissions, ensuring our metrics are consistent and benchmarked against the leading green multi res companies in North America. We are fully committed to being amongst the leaders in ESG for multi residential REITs and working diligently to reduce our environmental footprint, ensure effective and ethical governance and invest to maintain sustainable economic growth. Slide 16 profiles showing strong same property rental rate growth and NOI growth by region for Q3 twenty nineteen. The importance of geographic diversification is evident in this slide as it highlights the NOI growth of not just Ontario at 7.8% this quarter, but also Halifax, all three New Brunswick cities and Charlottetown. Our properties in Ottawa, London and Cambridge GTA maintained excellent occupancy and rental growth for both routine and repositioned units this quarter, delivering NOI growth of 9.9%, 8.5% and 5.4%, respectively. Once kiln was leading market for rental growth for many years, the Newfoundland economy has been challenged for the past 3. For Q3 this year, vacancy increased nominally to 20 basis points by 20 basis points quarter over quarter. But average rents improved by 80 basis points, so there are signs of encouragement in the market. St. John's economy remains dependent on oil, so when the Atlantic Provinces Economic Council states Newfoundland's GDP should grow 2.7% for 2019 and an additional 2.4% in 2020, bolstered by the ramp up at Hibernia and Husky's White Rose projects, we expect St. John's occupancy to improve noticeably next year. In Alberta, Edmonton same property results consist of 2 properties acquired in 2017, Wayberry and Tisbury. These properties are taking longer to stabilize than expected. Their combined occupancy for Q3 2019 was 85.4%. However, I am pleased to report that their current occupancy in November is now 90%. As well, Killam's 176 Unit Vibe Loft property also located in Edmonton, which is not part of the same property numbers having been acquired mid year 2018, is 97% occupied, giving Killam the combined Edmonton occupancy of 93%. We are optimistic this trend will continue into 2020. We are pleased with our 531 unit Calgary portfolio this quarter. Same property occupancy was up 60 basis points and average rental rates improved a healthy 3.9%. Calgary feels like it's stabilizing with overall occupancy at 95% this quarter. I will now hand you back to Philip to provide details on our acquisitions and new developments this quarter. Thank you. Thank you, Robert. Slide 17 details our annual acquisition history Killam has acquired $145,000,000 of assets in the 1st 9 months of 2019. We have exceeded our minimal acquisition target for the year and with the recently closed public equity offering, we will continue to look for accretive opportunities to add to our portfolio. During Q3, Killam purchased a 48 unit property in Fredericton, New Brunswick as shown on Slide 18. The purchase price of this 48 unit building was $9,250,000 with an all cash yield of 5.4%. The building is currently 100% occupied. Subsequent to the end of Q3, we purchased a 3.59 site seasonal manufactured home community located in Shediac, which is located just outside Moncton, New Brunswick for $3,800,000 Since our development project program started 8 years ago, we have completed 11 development projects in 5 provinces consisting of 1200 units at a cost of about $300,000,000 Our most recently completed development Frontier is shown on Slide 20 21. Co development of RioCan opened on June 1. Frontier was completed on budget and on time and is currently 90% leased. We expect to be fully leased in the next 2 to 3 months. The all cash yield on this development is approximately 5.25%, a healthy 125 basis points above current cap rates. This has resulted in a $9,700,000 gain in fair value to date on our 50% interest. Slide 22 shows a rendering of Frontier in Latitude. Although project development costs have increased per unit on the 2nd phase, the expected rents have also increased due to strong market demand in the frontier. The expected all cash yield is still 5.2%. We broke down in Q2 on the Latitude and progress photos of this 209 unit project are shown on Slides 23. The expected completion date is in late 2021. The progress photos of our Shorefront development located in Charlottetown, PEI are shown on Slides 2425. We are pleased to have broken ground on the K in Mississauga. This 128 unit development as shown on Slides 2627 has a $56,000,000 budget with an anticipated all cash yield of 5%, approximately 150 basis points higher than the current market cap rates. Construction will take 24 months and the expected completion date is in mid-twenty 21. Finally, we continue to refine and advance our development pipeline. A full list of our development pipeline is included on Slide 28. It's worth noting that over 90% of Killam's future development pipeline that is scheduled to be completed in the next 5 years is located in Ontario and Alberta. To finish, Q3 has been a very good quarter with strong operating and financial performance. Our focused strategy is leading to increased earnings, a stronger balance sheet, more geographical diversification and one of the highest quality apartment portfolios in Canada. This concludes the formal part of the presentation and we will now open up the call for questions. Thank Your first question comes from Jonathan Kelcher at TD Securities. Please go ahead. Thanks. Good afternoon. Good afternoon. First question, just on the repositioning program. What markets are you generally doing that in? You know what, actually most markets, because we're doing it as units come vacant. So we were not taking any properties offline, Jonathan. So it is broadly based through the portfolio. Okay. And then if I look at your 2020 target, and do a little bit of the math on Slide 13. It looks like the expected yield on your cost goes up a little bit from 2019. Is there anything to that or am I just being too fine with the details there? We think it's just a range. We're going to be in the same range. I think last year we would have reported, if I recollect properly, it's 14% this year, it's tracking at 13%, but I think we're in the same range more or less. Okay. Because it looks like sort of 16% to 19% for next year based on what you have there. And then just switching gears, the gap between renewals and turnover, is there how much of a difference is there in that in the rent controlled markets versus non rent controlled markets? Well, I don't have the answer right off. I do know one of the markets has was 2.1%. Yes. No, I can speak to the hi, Jonathan, this is Nancy. I can speak to the turnover that most of we have seen some tightening in our Ontario market on turnover. That's mostly and our other open markets, our number has pretty much stayed consistent. This whole 2 thirds of renew and 1 third churn, it has come slightly. It come down slightly as we've seen some more demand here. But I would say mostly we've seen a lot of tightening in Ontario. Okay. Actually I was trying to get Yes. The rent increases? Yes, the rent changes. I mean it's certainly they've been high in those markets, but they're high in our other markets too. So when you look at the weighting of our portfolio and to be at the kind of 5.5% range, We're seeing it. We're seeing those higher increases in Halifax and in New Brunswick and in Ontario. I'd say those are the areas, all of those. Ontario probably stands out a little bit higher than that, but those markets are all strong because offsetting that a bit is a bit more of the weakness that we would have talked about in Newfoundland and Alberta too. So we're seeing very healthy numbers in most of our markets. Okay. And just following up on that, are you finding that you're able to start to push on renewals in Halifax? Or do you just sort of keep them in the 2% range and get the gains on turnover? I'd say that we are when you look at what we provide those numbers to say to get to 2% well that's a healthy increase from what we were seeing even just a year ago and certainly compared to 2 years ago. So we look at it market by market and building by building and where there's opportunity, we look at that. But certainly, we're getting more on the churns. Okay. You mentioned the Halifax market in particular. The average rent in this market is about $1100 to $11.50 So getting 2% is $20 $22 or so. So there's the ability to probably move it a little higher in that market because those rents are so reasonable when you compare it to owning a house, but the value delivery on 2 bedrooms at 11.50, all you have to pay is electricity because we cover the heat. That's good value. Okay. Thanks. I'll turn it back. Thank you. Your next question comes from Joanne Rodriguez at Raymond James. Please go ahead. Hi, Joanne. That's close enough. I was just wondering looking at the appendix, I don't know, maybe it's just the scale of the graph, but it doesn't seem like there's a dramatic drop off in incentives in Halifax, New Brunswick, but doesn't seem like Ontario is dropping. Given how strong that market is, I don't know, maybe can you add some color on that? So yes, so the rental incentives, I think, on that graph, the way it's showing in Ontario there has to do with a property that we have supplements for in Toronto in the GTA, our Ossington property. We have some rental supplements that we consider as incentives. So you'd see that's pretty flat. So other than at that one specific property, their rental incentives are virtually they're minimal in Ontario as well. And those subs that relates to a long term agreement. Okay. Yes. So it's more like a sub subsidy, not an entity? Yes. Correct. It's part of the contract on the property. Okay. And then just in terms of acquisitions focusing on outside of Atlantic Canada, are you guys looking at Quebec or Montreal at all? Our primary focus is Ontario and out West. Okay. Okay. I'll turn it back. Thank Your next question comes from Matt Cormack at National Bank Financial. Please go ahead. Hi, guys. With regards to your suite repositioning program, just wondering how you think of building improvements more generally? And if you would do those in advance of the suite repositioning or if you reposition the suites and then look at common areas thereafter? We would typically run those on their own programs. What we found is the exterior work certainly is revenue enhancing. But most importantly to our tenants when we survey them is about their units. So if we can get it and get the unit done, we can come back and finish the rest if that's necessary. So there's not really a requirement that you have to be aligned. We don't see a big lift there. With a renovated unit in an older property, that unit on its own can command a fairly decent rental return. Okay. And would you say, I mean, obviously, turnover governs your ability to renovate these. But at this point, I would assume there's money to be made on pretty much every suite that you own or are there still assets that you wouldn't necessarily look at? So it's obviously in the older product, not the newer product, but So in the older product so the 11 new builds, you wouldn't touch those for some years now because they're current. But the other properties, it's interesting how much the appetite is in the marketplace for renovated units. And it could be anywhere in any market. If we renovate a unit, there's a return to be had and it's typically in double digits. And so we're motivated to on turn units that we can get in there to do that. And in terms of the spec that you're putting in these, obviously, it's probably more expensive to replace, but does it last longer than what you had previously in the unit? We haven't had them all done long enough. I will say this about the flooring. So in some of the buildings, especially in the Ontario market, where they would have had hardwood flooring, that's very durable, it lasts a long time. These days, we've landed on a newer product for flooring that I think has a much longer life than we've seen with others. Carvers don't last long as they used to, so and they're not popular in any event. But really this is called luxury vinyl tile. And it's a very good product, durable, easy to install and not affected by water. So it's a real so that will last a long time. Okay, great. Thanks. Thank you. Your next question comes from Kyle Stanley at Desjardins Capital Markets. Please go ahead. Thanks. Hi, everyone. Just one quick question from me. Would you be able to disclose the NOI contribution from Frontier during the quarter? So the NOI, I don't want to give a lot of details, but I would say that when you look at I know the FFO contribution is pretty slim in the quarter when you look at the interest expense that we would have had and because of the lease up. So it's marginal. So certainly, I would say it was positive from an FFO perspective, but we have not yet really seen the juice from that acquisition in this quarter. I'd say Q4 is when we're really going to start to see that. And when we look at 2020, that's when we're going to see some the real benefit from that from an earnings perspective. Okay. That sounds good. Thanks very much. Thank you. Your next question comes from Brad Sturges at IA. Please go ahead. Hi, there. In terms of the acquisition opportunity you see today, obviously, your preference is the new builds. Are you seeing any portfolios or smaller portfolios that would be of interest today that you're looking at? Or is it if we're thinking about acquisitions, still more of the one offs? Brad, it's Phil here. The acquisition environment there's still a lot of product. Everything is very competitive in terms of trying to buy it. But there's a number of opportunities that are just consist of a single asset whether they're at West or in Ontario. But there is also probably known to every sort of multifamily REIT out there and pension fund that there's 3 plus midsize portfolios in Ontario and there's 1 large portfolio for sale currently here in Halifax. That's attracting a lot of attention right across the board. Very big pit from our point of view, big purchase items. We're looking at it, but it's way too early to tell if we're going to be the eventual winner on any of them. Got it. And would those be more of a value creation opportunity? Or would they have a component that does have the new build that will kind of fit into some of the assets you have been buying recently? Well, I mean I can speak to the Halifax one which is public information. It's 7 or 8 buildings, 1500 units. With really just one new property, but most of the portfolio, if not all of it is very well located, very well maintained. That's just good product, but the question is, it's we do have a lot here already. Okay, great. That's good color. Portfolios are older stock, first time coming available in many, many years. Yes. You said Ontario, correct? Yes. I guess whereabouts in Ontario are the portfolios generally Kisner Waterloo. Okay, great. Thank you. Your next question comes from Troy MacLean at BMO Capital Markets. Please go ahead. Good afternoon. Just on Ottawa, it was very strong this quarter. Can you talk about some of the things that are driving that and how much more room you think there is to push rents and occupancy in that market? I think Ottawa, it's a big urban center and it's in Ontario and really it's a lot of it is driven by job creation and also the immigration increases in population. And those two things alone are driving the multifamily market. Phil, before you mentioned your target markets for acquisitions, but are there any new markets you're looking at entering? Montreal is a big one that a lot of people seem to try to get exposure to. Is that something that's on your radar screen? And if you were to look at a new market, what kind of scale would you need kind of going in? Would you need a big portfolio or do something through maybe on the development side? Well, the I'll try to answer all those questions that you posed right there. I mean, Montreal is a market that we've all obviously had looked at over many years over the years as we've been in business. And right now it's a sought after market for sure. The new markets that potentially might enter into for us would be sort of the western part of Canada. And obviously, we're in the two cities in Alberta and the other market that eventually we think has great opportunities and also the future of it would be the southern part of BC eventually. And then how do you get into a new market just like we got into the markets in Alberta, it's done by one asset at a time. Right now, we have a base in both of those cities and it's just basically getting one asset and then growing it from there. The opportunity to go in and get a midsized portfolio or a large portfolio in a new market, I think it's very limited for us these days. Thank you. That's it for me. I'll turn it back. Thank you. There are no further questions at this time. Please proceed. I would like to thank everybody for participating and listening today and we look forward to reporting our Q4 results in February of 2020. Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.