Good morning, ladies and gentlemen, and welcome to the Killam Apartment REIT Third Quarter 2018 Financial Results Conference Call. After the presentation, we will conduct a question and answer session. Instructions will be provided at that time. Please note that this call is being recorded today, November 8, 2018, at 10:00 A.M. Eastern Time. I would now like to turn the meeting over to your host for today's call, Philip Fraser, President and Chief Executive Officer. Please go ahead, Mr. Fraser.
Thank you. Hello, and thank you for joining Killam Apartment REIT's Q3 2018 conference call. I am here today with Robert Richardson, Executive Vice President, Dale Noseworthy, Chief Financial Officer, Erin 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 CAD 27.1 million, compared to CAD 14.6 million in Q3 2017, and earned funds from operations of CAD 0.26 per unit, a 4% increase from CAD 0.25 per unit in Q3 2017. We have made additional progress on our strategic targets in the first three quarters of the year, as summarized on slide four. Based on strong top-line revenue growth, Same Property NOI has increased by 3.9% compared to Q3 2017, and 4.9% year-to-date. Following these results, we believe we will be on the upper range of our Same Property NOI target for the year. We purchased CAD 102 million of properties in the third quarter, and subsequent to the end of the Q3, we have acquired another CAD 45 million of properties.
Of the assets acquired, 77% are located outside Atlantic Canada. Killam expects to generate 27% of its NOI from Alberta and Ontario in 2018. Saginaw Park, our development in Cambridge, which opened in April, is now 100% leased. The Alexander, our most recent completed development in Halifax, opened in September and reached substantial completion the 1st of October. The Alexander is currently 77% occupied and 92% leased. I will now ask Dale to recap our financial results.
Thanks, Phil. Slide five shows our Q3 and year-to-date financial results. Killam generated FFO per unit of CAD 0.26, 4% higher than Q3 2017. Year to date, we generated CAD 0.71 in FFO per unit, an increase of 6% from last year. AFFO per unit was up 4.8% in the quarter and 9.4% year to date. Same property revenue was up 3.1% in the quarter and 3.7% year to date. As illustrated on Slide six, overall rental rate growth continues to trend higher. The 2.5% increase in rents achieved this year is 70 basis points ahead of last year and the highest average rental rate increase since 2012. We've also decreased rental incentives, which are down 30 basis points year-over-year. With this continued upward revenue trend, we expect to exceed our budgeted revenue targets for 2018 and achieve the higher end of our NOI guidance.
As shown on Slide seven, operating expenses were up 1.7% in Q3. Savings were realized in utility and heating costs due to lower natural gas prices in Ontario, as well as reduced consumption as Killam benefits from efficiency projects installed in the last two years. These savings were offset by inflationary increases and timing in general operating expenses. Property tax expense remains relatively flat quarter-over-quarter as rising property assessments were offset by successful tax assessment appeals. In total, Killam's same property NOI margin increased by 50 basis points and 70 basis points for the quarter and year to date, respectively. Killam's debt metrics are highlighted on Slide eight. Debt as a percentage of total assets was 49.1%. Our interest coverage ratio of 3.16 times has increased over the past four years, and debt to EBITDA was 11.39 times at quarter end.
This ratio was impacted by the timing of recent acquisitions and increased construction financing on our developments. Normalized for annual earnings from recent acquisitions and developments, debt to normalized EBITDA is 10.4 times. Slide nine highlights our debt maturity profile, including average apartment mortgage rates by year versus prevailing CMHC-insured mortgage rates. Interest rates were lower on refinancings to date in 2018, but we expect to refinance apartment maturities in the next 12 months at higher rates than the weighted average interest rate on maturing debt of 2.82%. Beyond 2019, we also anticipate higher interest rates on mortgage refinancings. We have laddered our debt maturities and reduced overall leverage to lessen our exposure to rising interest rates. As shown on Slide 10, through acquisitions, developments, capital improvements, and appreciation of existing properties, Killam's real estate portfolio has grown to CAD 2.7 billion in value.
We are acquiring and developing new high-quality assets in prime locations. This, along with strong fundamentals, has translated into compression in the weighted average cap rate of our portfolio, including an 18 basis point tightening since year-end 2017. This decrease in cap rates, coupled with growing NOI, is reflected in CAD 100 million of fair value gains so far in 2018. I'll now turn the call over to Robert, who will provide details on our operating performance this quarter.
Thank you, Dale. Good morning, everyone. As shown on slide 11, Killam continues to execute its strategy to increase unitholder value. Specifically, we increased funds from operations and net asset value based on three key priorities. Increase Killam's earnings from the existing portfolio. Two, expand the portfolio, diversifying geographically through accretive acquisitions with an emphasis on newer properties. Number three, since 2010, Killam has been developing high-quality properties in Killam's core markets. I will focus on Killam's operating performance year-to-date and our key revenue and expense management initiatives before turning the call back to Philip to discuss our development pipeline and recent acquisitions. With Killam's existing portfolio of 15,500 apartment units, 5,300 MHC sites, and our expanding commercial base, we are focused on maximizing unitholder value. Slide 12 highlights the creative and innovative programs we execute to achieve our FFO and net asset value growth goals.
Top line growth and expense management remain key priorities, but additional metrics that are more subjective, such as superior customer service, technology gains, and enhanced analytics, are also critically important. For the last four years running, Killam has received a stellar 90% tenant satisfaction rating in our annual tenant survey. This survey is independently managed by Corporate Research Associates, and the results reflect the caring and committed service delivered by Killam's skilled employees each and every day. Killam's human resources and property management teams, working together, hire and retain excellent employees that understand Killam's core values and our tenant satisfaction imperative. Killam seeks continuous improvement and provides the tools to enable our staff to perform most efficiently by using leading technologies for leasing, property management, and property maintenance. Slide 13 details Killam's strong same-property rental rate growth and property occupancy results for Q3 2018 by region.
Given continued strong demand throughout our portfolio this quarter, Killam has successfully moved rent 5% as we attract new tenants on unit turns. This is a 160 basis point improvement versus Q3 2017. On tenant renewals this quarter, representing two-thirds of our units, which is consistent with prior years, we delivered average rental rate gains of 1.7%, a 70 basis point improvement over the same quarter in 2017. Halifax, Killam's largest market, is one of four Killam markets reporting a 6% or greater average rental rate increase on new leasing, plus a better than 2.1% increase on renewals. Our management and leasing teams in each market delivered record-high portfolio occupancy in Q3 2018. Occupancy was a strong 97% plus in all markets except for two. Both St. John's and Calgary continue to be impacted by low oil prices. However, recent trends are encouraging.
Newfoundland's offshore exploration program is again ramping up. This was reinforced by yesterday's sale of a record CAD 1.38 billion in offshore exploration licenses. Meanwhile, Killam's only same-store property in Calgary, Grid 5, is now 96.1% occupied. It is doing fine. The chart at the bottom of slide 13 highlights that Charlottetown remains better than 99% occupied. We expect this trend to continue, given the higher rates of international immigration and very little new multi-residential supply in the PEI market. Overall, Killam reported consolidated same-property occupancy of 97.1% in Q3 2018, the same as Q3 last year. Market demand for quality rental units remains robust. Killam's portfolio is well-positioned to achieve additional rental growth.
In response to this opportunity, as highlighted on slide 14, we have accelerated our suite repositioning program in 2018 to CAD 4 million, with a target of 200 units to be upgraded, up from CAD 1 million invested to upgrade 43 units in 2017. Year-to-date 2018, 134 reposition units have been completed or are underway. With finished units yielding an average ROI of 14% and an average monthly rental increase of CAD 253. With 200 repositionings for 2018 and 300 repositionings planned in 2019. We expect to generate an aggregate CAD 1.5 million in annualized revenue growth from these upgrades. Killam has identified approximately 3,000 additional units for repositioning. Once these are completed, we expect to earn an estimated CAD 9 million in additional annualized rental revenue, representing an approximate CAD 170 million increase in net asset value.
The average cost to reposition a unit is approximately CAD 20,000, or CAD 60 million for these 3,000 units. Slides 15 through 20 highlight examples of the type of unit renovations being completed this year at 30 properties throughout our portfolio. During our Q2 2018 results conference call, we profiled four properties included in our repositioning program. Today, we'll quickly run through another five properties. Slide 16 shows one of our Rivers Edge buildings in Cambridge, Ontario. Built in 2004 and 2008, these two mid-rise buildings have 225 units in total and overlook the beautiful Grand River. This property illustrates the demand for updated, high-end units in properties that are only 10 to 15 years old. A CAD 13,000 investment with a focus on kitchen, bathroom, and flooring upgrades generated an average rental lift of CAD 150 a month, equating to a 14% ROI.
As well, these rental units are well-positioned to compete in the market for another 10 to 15 years. Slide 17 shows our Brentwood Apartments in Halifax, a 240-unit, three-building property that was built in 1968. We identified the opportunity to increase returns at this property three years ago and have repositioned 80 units to date, continuing to maximize value as units turn. The average rent for a two-bedroom unit was only CAD 850 per month. However, with CAD 19,000 invested, we are now earning 26% more rent, or CAD 220 per month, for each unit, a gain of overall 15%. Slide 18 highlights Fort Howe in Saint John, New Brunswick. This 153-unit property overlooks the Saint John River and Harbour and was built 48 years ago.
By investing CAD 32,000 per unit to update kitchens, bathrooms, and again, flooring, we earned an increase in rental rates of CAD 275 per month or 32%, for an overall 10% return on investment. Slide 19 shows our 84-unit Torbay property in Newfoundland. This property was built in 1972 and has a current two-bedroom rent of CAD 895. Our average investment to upgrade kitchens, baths, and flooring is CAD 25,000 per unit to achieve a CAD 250 per month average rental lift and a 12% return on investment. Lastly, slide 20 shows our 50-year-old Parker Street property in Halifax. This 239-unit mid-rise highlights the opportunity to update kitchens, bathrooms, yes, flooring as well, at an average per-unit cost of CAD 21,000. We can move rents up CAD 220 per month or 24% to generate an ROI of 13%.
Each of these properties has little to no vacancy. We reposition units as they turn, and with experience, the units are now offline, on average, only 28 days. In conjunction with driving revenue growth, Killam is actively managing expenses to optimize net operating income. As shown on slide 21, Killam is executing its five-year, CAD 25 million energy efficiency plan focused on energy savings, such as insulation of ultra-low flow toilets, LED lighting retrofits, and heating system upgrades. These projects help mitigate the impact of expense increases from rising energy rates and other inflationary pressures. To date, we have invested approximately CAD 10 million in energy projects and have achieved a 24% return, essentially a four-year payback. Slide 22 highlights Killam's commitment to technology that helps maximize earnings growth as we employ leading-edge processes to better service and engage our residents, prospective tenants, employees, and suppliers.
Killam's investment in its property management platform, including the education of our skilled staff, enables Killam to integrate new and innovative technologies as our business continuously evolves. All Killam employees have smartphones or tablets that deliver faster response times to our tenants' inquiries, enhance staff efficiencies, and reduce paperwork, all saving time and money. We've rolled out mobile maintenance work orders, property inspection apps, and are currently fully integrating our front-end online leasing, marketing, and customer relationship software. We are in the pilot stage with our front-end CRM software and expect to be fully operational by the end of Q1 2019. This will give us the ability to deliver the high-quality service that our prospects and residents have come to expect as we maximize rental opportunities and further reduce vacancy.
Having real-time access to this data is key to ensuring we can rapidly analyze our markets and better enables Killam to make informed and more accurate operating decisions. The multi-residential fundamentals remain strong in our key markets. Slides 23 to 25 highlight the Halifax, New Brunswick, and Ontario markets, three markets that performed very well in Q3 2018, generating both excellent occupancy and NOI growth, as noted. At Killam, we are pleased with the gains we have made and continue to make. We also know there is no finish line, so we will pursue improvements and innovations with enthusiasm. I'm going to hand you back to Philip to provide details on our acquisitions and new developments this quarter. Thank you.
Thank you, Robert. Slide 27 details our acquisition activity year to date. Killam acquired CAD 102 million in Q3. Subsequent to the end of Q3, we continued to expand our portfolio with an additional CAD 45 million in acquisitions in Ontario and Alberta, bringing the total to CAD 271 million year-to-date, the largest in the history of the company. Slides 28 and 29 show our new Edmonton asset, The Vibe Lofts, that closed on August 27th. This asset is a new six-story, 178-unit apartment building located just west of the downtown core. The CAD 47 million purchase offers tenants condo-quality finishes, 10-foot ceilings throughout the building, and a variety of in-house amenities, including a collaboration lounge, yoga studio, gym, and a rooftop patio. The average monthly rent is CAD 1,444 per month and is currently 87% leased.
Turning to slide 30 and 31, Killam acquired a 107-unit building known as the Hurley Street Apartments in Charlottetown on August 14th. The average unit size is 1,100 sq ft with an average monthly rent of CAD 1,500 and has attracted mainly senior citizens. Slide 32 highlights our new acquisition, 151 Greenbank Road, a new five-story concrete apartment building located in Ottawa. The 60-unit property was acquired on September 26th for a purchase price of CAD 20.7 million, representing a stabilized all-cash yield of 4.6%. The property is currently 95% leased. The average rental rate is CAD 1,729 per month. 151 Greenbank Road has condo-quality finishes including granite countertops, underground parking, and modern building amenities, including a common and fitness room. On October 1st, Killam purchased The Trio at Sherwood, as shown on slide 33. Two new four-story wood frame apartment buildings located in Calgary Sherwood neighborhood.
The fully occupied 158-unit property was acquired for a purchase price of CAD 39 million, representing an all-cash yield of 4.9%. The property is located adjacent to Killam's recently announced 10% interest in the 13.6-acre Nolan Hill development. Subsequent to the quarter end, Killam purchased Parkwood MHC for CAD 2.6 million, a park containing 123 sites located in New Minas. This new park is in close proximity to Killam's Valleyview MHC, which allows for cost efficiencies in managing the park. On the development front, slides 34 and 35 summarize our recent completed Saginaw Park. The 94-unit, seven-story development includes several design features that improve the tenant experience and promote efficiency. Examples include condo-quality kitchens, smart locks, and separately metered water. We have recognized a CAD 4.9 million fair value gain related to Saginaw Park, reflecting the value created from our development program.
The building is currently 100% leased and is expected to be fully occupied by the end of the year. Another important milestone was the opening of The Alexander development in downtown Halifax. Details of The Alexander and photos are included on slides 36 and 37. Killam has a 50% interest in The Alexander development and is expected to increase its ownership to 100% in the near future. Progress is on track with our Frontier development in Ottawa, a project we are co-developing with RioCan, as detailed on slide 38. The first phase of the 23-story tower, 227-unit building, will have geothermal heating and separately metered water, increasing our operating margins and reducing our environmental footprint. The building is on schedule to be completed in Q2 of 2019. A rendering of the second phase is shown on slide 39, and we are in the design and approval stages for this project.
We are excited to have broken ground on our new development in Charlottetown, PEI, as shown on slide 40. The five-story building will contain 78 units with underground parking overlooking downtown Charlottetown on the waterfront. The average size of the units will be 1,020 sq ft, with amenities that include a gym, social room, and a library. The project's budget is CAD 20.8 million, with an anticipated all-cash yield of 5.6%. As shown on slide 41, Silver Spear II, our 128-unit development in Mississauga, is expected to break ground in Q1 of next year. Construction will take 24 months with a CAD 49 million budget with an anticipated all-cash yield of 5%. Slide 42 shows our proposed design for the Weber Scott Pearl in downtown Kitchener. We are working on all approvals for this 173-unit development and would be very pleased to start construction in the second half of 2019.
Killam increased its multifamily development in Waterloo with the purchase of an additional 16,500 sq ft development site on Erb Street for CAD 2.3 million during Q3. Subsequent to the quarter, a 0.86-acre site on Dietz Street for CAD 2.9 million, expanding the area of the Westmount residential development opportunity by 1.24 acres to 3.26 acres. These purchases, along with our current proposed multi-residential opportunity, are shown on slides 43 and 44. Consolidating additional land parcels adjacent to Westmount Plaza is expected to allow for greater density and flexibility with Killam's future multi-phase residential Westmount development, increasing the overall development opportunity from 560 units to approximately 800 units. Finally, we continue to advance our development pipeline. A full list of our development pipeline is included on slide 45.
It is worth noting that 70% of Killam's development future pipeline is outside Atlantic Canada, as we continue to grow our presence 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.
At this time, if anybody has a question, please press star one on your telephone keypad. Again, that would be star one on your telephone keypad. Your first question comes from Mark Rothschild from Canaccord. Your line is open.
Thanks. Good morning, guys.
Good morning, Mark.
Thanks. With same property NOI ROI trending towards the 5% range, close to it for the year, continuing that trend and with strong fundamentals and occupancy even improving in sub-markets, would it be fair to assume that you should be able to be at around that level as we head into 2019?
It's a tough question for us. We don't like to provide that type of guidance, Mark, as you would know from these years we've worked together.
Right. I do know.
Hey, you're persistent asking the question, but that's all right.
Well, I'm asking based on what we've seen already.
Into the REIT.
I'm sorry, Mark, say again?
I'm just asking based on what we've seen already, without really talking about what your expectations are, just from the fact that occupancy's moved and rental rates seem to be moving higher.
The markets are strong, and we could probably be bold and say yes. What we would say is that it's in the range, and it's probably, for us, we think, the high end of the range, as Dale noted.
Okay. No, that's fine. You've reduced leverage somewhat over the past year. To what extent is that going to be a continued focus, or are you comfortable with where leverage is as you fund these development projects and have some completed?
I think, Mark, like we've been saying for a number of years, the mid-to-long-term goal is reduced leverage. Whether or not you see opportunities and it ticks up slightly a little bit over maybe a couple quarters, we're comfortable with that. Overall, still the overwhelming driving force is to reduce leverage in a way that we can still show growth quarter-over-quarter, year-over-year.
Okay. That makes sense. Then maybe just lastly, in some of the smaller Atlantic Canada markets, at least smaller than Halifax, some really good numbers, and you spoke about how fundamentals are very strong. To what extent do you think this is a long-term trend, or is there something unique going on right now in some markets, whether it's Charlottetown, whether it's Saint John?
I think the overwhelming trend is still, we have to look at the whole country relative to our immigration policy. As we continue for the last couple of years, and I think it's for the next few years, with the increase over that 250,000, every part of the country is getting their share of increased immigration, which is very positive for the housing sector.
I think layering on top of that would be, to a certain extent, the urbanization of Canada. Atlantic Canada is actually more rural than most, we're seeing that in the markets. Then an aging population that is making a decision that living in quality multi-res housing is an alternative. We're seeing a bit of that. Everything's coming together. The markets are strong.
Okay, great. Thanks so much.
Great. Thank you.
Again, if anyone has a question, please press star one on your telephone keypad. Your next question comes from Brad Sturges from Industrial Alliance. Your line is open.
Hi there. Obviously, it's been a pretty successful year from the acquisition point of view, and noted a pretty strong pipeline in Ontario and Alberta. Just want to get a sense of further opportunities you're seeing in the market, and should we expect to continue to see more deal flow, I guess, coming from developers or those of newly constructed assets?
To answer, I think, both of your questions, I would say that in the last 3-6 months, the amount of opportunities that are out there right across the country are probably the greatest I've ever seen. There's a lot of product, and there's a lot of product that we'd be very interested in sort of owning, but we've been selective and very happy with the properties that we've been able to acquire. Saying that, I think over the next few months, we're just going to sort of take a little bit of a pause and sort of understand what we've bought, bring it in-house, and just make sure that everything is running smoothly, and especially the projects that we bought brand new, and there's still that small 5%-10% initial lease-up in the properties. That takes a few months to sort of figure out everything.
The answer is, I had one broker tell me about a month and a half ago that there was almost CAD 2 billion of apartments for sale in Canada at that time. There's lots of deal flow if you're active.
In terms of vendor expectations, are you seeing any changes there since Obviously, you had some recent acquisitions, but has there been any further changes to the expectations?
No. It still is very sort of the pricing continues to sort of only go one way.
Yeah. Okay. Great. Thank you.
Thank you.
If anybody would like to ask a question, please press star one on your telephone keypad. I have no further questions at this time. I turn the call back over to the presenters for closing remarks.
Once again, thank you everybody for participating and listening today, and we look forward to talking to everyone at the release of our fourth quarter in April. Not April, February of 2019. Thank you.
Thank you, everyone. This will conclude today's conference call. You may now disconnect.