Good afternoon, ladies and gentlemen, welcome to the Morguard North American Residential Real Estate Investment Trust third quarter results conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Thursday, November 1st, 2018. I would now turn the conference over to Robert Wright. Please go ahead.
Thank you very much. As is customary, I will provide comments on the REIT's financial position and performance. We will open the floor for questions. In terms of our financial position, the REIT completed the third quarter of 2018 with assets totaling CAD 2.9 billion, compared to CAD 2.7 billion in December of 2017. The increase in assets during 2018 was due to the acquisition of a property under development of CAD 15 million, a fair value gain of CAD 134 million, and a change of foreign exchange rate year-on-year having an uplift of approximately CAD 48 million. The REIT finished the third quarter of 2018 with CAD 18 million of cash on hand and CAD 12 million owed to Morguard Corporation under its revolving credit facility.
The REIT has a CAD 100 million credit facility which can be drawn on either Canadian or U.S. dollars and which the REIT can use for acquisitions and general corporate purposes. The REIT completed the third quarter of 2018 with CAD 1.3 billion in long-term debt obligations. There was no refinancing activity in the quarter. As at September 2018, the REIT overall weighted average term to maturity was 6.1 years, decreased from 6.2 in the prior year. The REIT weighted average interest rate decreased to 3.48% from 3.5% in December. The REIT continues to make progress in reducing its overall leverage. The REIT gross book value improved from 51% in December of last year to 49% in September of this year.
Morguard has an IFRS asset management value of CAD 23.75 per unit as of September 30, 2018, compared to market price of CAD 16.50, still reflecting a significant discount to our current trading price. Turning to the statement of income, net income increased by CAD 17.1 million-CAD 25 million for the three months ended September 30th, 2018, compared to 2017. An increase in NOI and higher non-cash charges to fair value on real estate properties, particularly offset by higher fair value loss in the Class B LP Units compared to 2017. Net operating income of CAD 38.2 million for the three months ended September 30th, 2018, increased by CAD 3 million, or 8.5%, compared to the prior year. Proportionate NOI increased by CAD 1.2 million, or 4.1%, to CAD 31.9 million, compared to CAD 30.7 million for the prior year. Interest expense increased by CAD 1.6 million for the three months ended September 30th compared to 2017.
Excluding the non-cash fair value adjustments, interest expense decreased by CAD 0.8 million. The REIT's third quarter performance has translated into basic FFO of CAD 15.5 million, an increase of CAD 1 million, or 7%, from the prior year. On a per unit basis, FFO was CAD 0.30 per unit for the three months ended September 2018, an increase of CAD 0.01 or 3.4% compared to CAD 0.29 per unit in the prior year. The change in foreign exchange rate of 1% per unit had a positive impact. The REIT FFO payout ratio for the three months ended September 30th, 2018, was 54.2%. In addition, the Board of Trustees of the REIT is announcing an increase in annual cash distribution of CAD 0.02 per unit, an increase of 3.03%. The increase is expected to be effective for the November 2018 distribution, payable in December 2018.
This will bring the distribution to CAD 0.68 per unit on an annualized basis from the current CAD 0.66 per unit. Operations. Operationally, the REIT has had a successful quarter with average monthly rents in Canada increasing to CAD 1,358. This reflects the quality of the Canadian portfolio and translates into 2.9% increase in rent levels from the prior year. While in the U.S., average monthly rents increased by 2.4%, having an average monthly rent of USD 1,231 at the end of the third quarter, compared to USD 1,202 at the end of the prior year.
The REIT continues to have strong occupancy, with Canada finishing the third quarter at 99.5% compared to 98.5% a year earlier. Occupancy in the U.S. continues to improve over the prior year. Occupancy increased to 93.5% from 90.7% in the prior year. Same property occupancy in the U.S. decreased slightly from 93.7% occupancy reported in June of 2018, resulting in an increase in new supply and free rent concessions offered by competitors. I will now turn the call back over to the moderator who will open the lines for questions.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. Should you wish to decline from the polling process, please press star followed by two. If you are using a speakerphone, please lift the handset before pressing any key. One moment please for the first question. Your first question comes from Jonathan Kelcher at TD. Please go ahead.
Thanks. Good afternoon. First question's just on the turnover so far this year. I guess it's about 14% on the Canadian portfolio, I'm just curious as to how that compares to prior years.
Yeah, I can answer that. Definitely, we are seeing a trend. The turnover is on a decline and is definitely lower than the previous years. In 2017, we experienced around 20%, and we're finding it's lower this year.
Okay. You're getting roughly 10% on turnovers. Is that something that we can expect going forward for the next couple of quarters anyways?
Yeah, absolutely. Our Mississauga properties annualized, we're getting 12.32% bump in the rent, and in downtown properties, we're getting close to 13%. Between 12% and 13% is what we are managing.
Okay. Then just secondly, given where you trade relative to your IFRS value, what's your appetite for acquisitions?
Well, that is a great question. I wouldn't say appetite. We always are looking at all kinds of product available both in the U.S. and Canada. We're also kind of reflecting on what is happening to the medium- to long-term rate. Now we're starting to continue to look at it, we are a little cautious about whether the interest here they want to continue to climb and whether that would change the pricing. It's an ongoing thing. We'll just continue to do that. If there's an asset that we think that we need to acquire, we will. We'll let you know if we do something. Thank you.
Okay. What about dispositions or any markets that you're currently in that you'd like to exit or reduce?
I don't think there's anything in the U.S. at this stage we are looking at. At this stage, we've made no decision to any potential disposition out of Canada.
Okay, thanks. I'll turn it back.
Thank you.
Thank you. Your next question is from Dean Wilkinson from CIBC. Please go ahead.
Thanks. Afternoon, everyone.
Afternoon.
Rai, if I could just continue on with John's question there. You look at the stuff that you've got in Canada, the stuff that's in Mississauga there. You take that out to the market. I don't think people would be shocked if that garnered something with a 3 in front of it in terms of a cap rate. You don't want to part with good assets, but the difference between what you could pick up stuff down in the U.S. for, is that something you think about? Or is it just, hey, the valuation's going to continue to increase on those Canadian assets, and we'll let the market take it where it takes it?
Well, we look a little differently than just because you think you can get 3 or something cap, which is not bad. Because some of these assets in Mississauga, they're core assets. It is not just that we want to trade something in the U.S. As you know, a real limit of Canadian assets are pretty scarce. I don't think just for the sake of that, selling at a lower cap rate versus buying at a higher cap rate is a benefit for us. Answering your question directly, we have no interest in selling the Mississauga asset.
Okay, great. I just want to look at the margins that you get off of those assets, and I look at some of the other Canadian apartment peers and that differential in the margins. I know you don't have insight into how they run their financials, but do you sense that your margin differential being a little bit lower is that you're perhaps a little more conservative when it comes to expensing things like R&M, where others might be capitalizing a little bit more of that? Do you have any insight into those differences?
Well, the truth of the matter, this is Rai Sahi. I don't even waste time worrying about what other people do, whether they are expensing or not. We run the business as efficiently as we can, not worrying about what other people are doing.
Fair enough. I guess if you're going to see the margin or the turnover continue to trend lower, with lower amount of turn you have less expenses associated with turns. It's likely that the margin actually does sort of tick up from here.
I don't know. I don't have a ball to that.
I guess we'll wait and see. That's it for me. I'll hand it back. Thanks, guys.
Thank you.
Thank you. Your next question comes from Yash Sankhala from Renaissance Capital. Please go ahead.
Good afternoon.
Hi.
Just on your U.S. NOI margins. Year-over-year, they were down, and I think it was partly because of the higher turnover rate and some other things. Maybe you could add some color around that, like what exactly happened. Is it related to incentives that you are offering? Is it related to new supply in the market?
John, do you want to handle that?
Sure. Our activities dropped earlier this year. Much of that vacancy we have eaten up over the last several months. We're now 94% occupied and 95% leased. In the quarter, we had to make all those units ready, and we had a very active quarter as well. More concentrated turns within this quarter, where lots of folks moved right over the summer months. Sometimes folks move more in the spring and fall, but we saw a higher concentration in that three-month period. That, coupled with the utilities, just drove those expenses up over this quarter. We expect it to be normalizing. It's definitely normalized now, and we expect it to be normalized through Q4, if that helps.
How are you guys dealing with new supply in your markets? Are you guys still seeing it?
It is market by market. There's definitely new supply in D.C. and in Chicago that we're dealing with every day. I would say in Chicago, we're in a much better place than we were this time last year. We also see the development pipeline starting to dwindle. We are still dealing with that, but we expect it to continue to improve, and the demand for apartments is strong. The interest rates creeping up a little bit has made the housing market weaken a little bit as well, which we saw very recently. We're confident that it will continue to improve.
Okay. Where do you think your U.S. occupancy will be by year-end?
I can't speculate that.
Higher or lower from here?
We expect it to stay in the same range where it is today.
Okay. Yeah, that's it for me. Thank you.
Thank you. Your next question is from Howard Dash from D.S. Chaumont. Please go ahead.
Mr. Sahi, the last quarter, there was a couple of apartments purchased by Morguard Corporation in Boynton Beach, Florida. Why were those not purchased by the REIT, and is there an intention that those will later be sold to the REIT?
Well, some of these are condos. John, do you want to add to that? Really, sometimes assets fit in corp as opposed to the REIT because they got some work to be done.
These were brand new, I believe, Mr. Sahi.
The Santorini itself was a lease-up, so it was currently unoccupied, so we didn't feel like it was a good fit for the REIT acquisition.
There was two of them.
Right. The Skye was a broken condo acquisition of 125 units. Again, that was attached to the deal with Santorini. They are related and purchased from the same party. Again, that was a bit of a complicated transaction where we're dealing with the lease-up as we speak.
Just a quick question then. Is there the possibility they will be then purchased by the REIT from Morguard?
I think we will look at that once it stabilizes, whether that should be the case or not.
Thank you very much.
Ladies and gentlemen, as a reminder, should you have any questions, please press star followed by the one.
If there's nothing else.
There are no further questions at this time. You may proceed.
All right. Well, thank you very much. We shall talk to you next quarter. Thank you. Thank you for attending.
Thank you.
Thank you.
Thank you.
Thank you.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.