Earnings Call: Q2 2018

Aug 2, 2018

Earnings release

Good afternoon, ladies and gentlemen, and welcome to the Morguard North American Residential Real Estate Investment Trust Second 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. This call is being recorded on Thursday, August 2, 2018. I would now like to turn the conference over to Paul Mietello. Please go ahead. Thank you, and good afternoon, everybody. And it's great to have you guys joining the conference call today. I'm Paul Miatello. I'll be moderating the call today. I'm the Vice President of The REIT and the Chief Financial Officer at Morgant Corporation. Mr. Sagi is not available to join the call today. But joining us on the call is Bob Wright, Chief Financial Officer Sanjay Ritija, Vice President of Canadian Operations and John Talano, Vice President of U. S. Operations. So with those brief introductions, I'll turn it over to Bob Wright, who will give us an overview of the Q2 results. Thank you, Paul. As is customary, I will provide comments on the REIT's financial position and performance. Then we will open the floor to questions. In terms of our financial position, the REIT completed the Q2 of 2018 with assets totaling $2,900,000,000 compared to 2 point $7,000,000,000 in December. This increase in assets during 2018 was due to the acquisition of property under development of $15,000,000 a fair value gain of $106,000,000 and the charge in foreign exchange rates during the year having an uplift in assets' value of approximately $77,000,000 On April 5, 2018, The REIT acquired the property comprising 116 suites located in New Orleans, Louisiana for the purchase price of $11,400,000 The property is vacant and designated as a property under development. The REIT plans to complete significant capital upgrades during the remainder of 2018, at which time initial lease ups will commence. The REIT finished the Q2 of 2018 with $22,000,000 in cash on hand and $4,000,000 owing to Morguard Corp under its revolving facility. The REIT has a $100,000,000 credit facility which can be drawn on in either Canadian or U. S. Dollars, which the REIT can use for acquisitions and general corporate purposes. The REIT completed the Q2 of 2018 with 1 point $3,000,000,000 of long term debt obligations. During the quarter, the REIT continued to make progress in strengthening its balance sheet through financing activities with the refinancing of 2 residential properties in the amount of $62,000,000 at the weighted average interest rate of 4.07, about 60 basis points lower than in place interest rate. The weighted average term of 10 years that resulted in 9,000,000 dollars of up financing proceeds. At June 2018, the REIT's overall weighted average term to maturity was 6.3 years, an increase from 6.2 percent at December of 2017. The REIT's weighted average interest rate declined slightly to 3.48 from 3.5 at December 2017. The REIT continues to make progress in reducing its overall leverage. The REIT's debt to book value improved to 51% in December compared to 49% June. MRG has IFRS asset value of $23.33 per unit at June compared to market value of $15,400,000 still reflecting a significant discount to trading value. Turning to the statement of income, net income decreased by $41,800,000 to $19,700,000 for the 3 months ended June 30, compared to 2017. The decrease was primarily due to lower non cash charges to fair value real estate properties and fair value BLP units compared to 2017, plus an increase in deferred tax compared to the prior year. Net operating income of $38,300,000 for the 3 months ended June 30, 2018, an increase of $3,200,000 or 9% compared to 2017. Proportionate share NOI increased by $1,600,000 or 5.3 $1,000,000 to $32,000,000 compared to $30,400,000 in 2017. Interest expense increased $2,200,000 for the 3 months ended June 30, 2018 compared to 2017. Excluding non cash fair value adjustments, interest expense decreased by 1,800,000 dollars The REIT's 2018 performance has translated into basic FFO of $15,700,000 generated for the 3 months ended June 2018, a decrease of $600,000 or 3.8 percent compared to 2017. On a per unit basis, FFO of $0.31 per unit for the 3 months ended June 30, 2018, a decrease of $0.01 or 3.1 percent compared to the $0.32 per unit in 2017. The REIT's FFO payout ratio for the 3 months ended June 30, 2018 was 53.6%. Operations. The REIT has been a successful quarter with an average monthly rents in Canada increased to $13.45 This reflects the quality of the Canadian portfolio and translates into an overall 3% increase over 2017. While in the U. S, average monthly rents increased 17.2% having an average monthly rent of US12.21 dollars at the end of the second quarter compared to US10.42 dollars at the end of the same period 2017. For the same property, average monthly rents increased 3.2%. The REIT's strong rent growth in the U. S. Markets in all places but Louisiana. The REIT continues to report strong occupancy with Canada finishing the Q2 of 2018 at 99.2% par for prior year. Same property occupancy in the U. S. Has started to see an improvement over last year's occupancy. Same property increased 93.8% from 93.2% in 2017. Same property occupancy in the U. S. Has improved from 92.7 occupancy reported at March 2018, resulting from increased marketing efforts at the beginning of the spring season. Occupancy levels at US properties acquired by the REIT during 2017 have been impacted by a new supply and leasing seasonality. Occupancy of all three properties acquired in 2017 improved since the Q1 of 2018 and have seen significant improvements in traffic and leasing activities. This trend is expected to continue throughout the leasing season in these properties. Management has seen recent improvements and expects the impact of the short term in nature as the competitive properties complete their lease up. I will now turn it back to the moderator who will open the lines for questions. Thank you. Ladies and gentlemen, we will now begin the question and answer Your first question comes from Jonathan Kelcher of TD. Please go ahead. Thanks. Good afternoon. First question on the New Orleans development, how much do you expect to invest in that over the balance of this year? Yes. The total program will probably end up being around $5,000,000 It could be a little bit lower. The scope is set on the building envelope budget, depending on how much we do on suite improvements. It could go lower than 5,000,000 dollars but it's so the answer is $4,000,000 to $5,000,000 Okay. And then when you get it leased up, what sort of return do you expect on the whole thing? We're expecting about in the range of 8% to 8.5%. 8% to 8.5%. Longer. A year. Yes. Okay. That's good. I noticed the incentives ticked up this quarter and actually quite a bit year over year. Is there any one market that that's where that's happening or is it sort of across the board? Maybe a little bit of color on that. Yes. I'll get maybe I'll turn that question over to John Tynan. Sure. The incentives specifically were in Chicago at Coast and in the DC markets where we had occupancy weakness in occupancy earlier in or late last year, earlier this year, and then also at one property in Atlanta. And those that was where the bulk of it was and that was specifically targeted at those three properties where we were experiencing those lower occupancies. And since that time, we have actually ended all of those. We've seen great results in Chicago. Coast is now 98% leased. So we are we have fixed that one. Briar Hill in Atlanta was in the low 80s last quarter. It is also 98% leased. So we've had some great progress there. But again, that was really going through a lease up this spring at those properties and we have finished with those. Okay. So we'll start to see that tick down next quarter? Absolutely. Okay. And then last for me is just on the G and A was $600 higher this quarter versus last quarter. I was wondering what a good run rate is going forward? Yes, it's a little higher. It's largely on timing of expenditures and some consulting bills that came in. So I think the number we're at is 3.6. Yes, and there's a little and yes, Chris just pointed out to you, there's a little bit of FX fluctuation in there as well, John, but sort of around 3.5%, 3.5%, 3.6% is a normal run rate. That's a good run rate. Okay, thanks. I'll turn it back. Thank you. Next question comes from Fred Blondeau of Echelon Wealth Partners. Please go ahead. Thanks and good afternoon. Hi, Fred. I just have two quick questions here. First, I was wondering if you could give us a sense of your acquisition pipeline at this point. It looks like you're a bit less active this year. Yes, a little bit less active. We're still looking at a lot of product, similar markets to where we're in, in terms of footprint right now. Just things are still to us looking pricey, especially in the face of what we think are going to be more rate increases in the year. We still think that there's that traditional sort of disconnection between buyer and seller. The seller doesn't think prices have moved and the buyers think prices have moved. So yes, so it's probably fair characteristic or fair to characterize it as it's a little bit slow right now, but we do we are looking at a lot just on a pricing basis, cap rate per door basis. We're just we're not seeing anything that we're jumping at right now. Okay. So it's fair to say that you don't necessarily have a pipeline at this point? Like I said, I mean nothing that's under contract. I mean nothing that's anywhere near that close. But like I said, we are still very active in terms of looking and investigating and lots of conversations going, but hard very hard to predict in this kind of market what's going to come to fruition. Okay. And just on Jonathan's question on incentives, What do you see in terms of new supply in your markets at this point? Is it fair to say that based on your comments, it seems like it's becoming less of a challenge here? I mean, I'll just start off by saying Chicago, it's still a bit of a challenge. I mean, there's a lot of there's still fair bit of supply, although it's less than what it was at this time last year. And it looks like it's continuing to slow down, but it's still an issue. Sort of beyond that comment, John, is there anything else you can add to that? We've had strong supply in South Florida. But as you can see from our occupancy and rents there, those have been performing well. So the demand and supply are matching. Everywhere else has been very stable. I would say Dallas is another area that continues to have a consistent supply. But beyond that, the only other area that has a significant supply would be in the DC and our Maryland markets. But that too has definitely improved over the last quarter as well. So the other areas of the country, Colorado, Atlanta, that definitely has calmed down as well. Perfect. Thank you. I'll leave it there. Thanks, guys. Your next question comes from Yash Sankpal of Laurentian Bank. Please go ahead. Good afternoon. Good afternoon. Just on your U. S. Occupancy, just looking out, where do you think your occupancy rate would be by the end of 2018? Like just a rough estimate like based on what you see? Joe, I'll handle that one. Well, we've seen very good trends recently. So with our busy spring and summer leasing season, we have the portfolio as a whole, it has already achieved very close to 95% occupancy. And that really is our sweet spot where we're trying to push rents where we can. So we are there and The U. S. Came into effect? What's that? About 95% in the U. S? Or you're talking about Canada and U. S? We're approaching 95%. It is very close today. And the goal is to stay around that, Mark. Okay. That's good. Also in terms of acquisition cap rates, like what do you see out there? Like can you give us some commentary around like where cap rates are and if they are like expectations are changing or not like anything? Yes. I mean we're seeing for the garden style wood frame, 3 story walk up, style product, 2 and 3 story walk up, depending on location, depending on construction and finishes, you're seeing cap rates in the low 5s, 5.5 and then up from there. As I said in my earlier comment, that has tended not to move over the last few quarters. We've seen maybe a little tiny bit of compression here and there in certain markets, but the cap rates have sort of remained stable, sort of in the face of interest rate increases that happened over a year ago, and that's what I'm sort of alluding to in my earlier comment. The boil has sort of come off. Certainly in U. S. Markets, we're seeing a little bit of deceleration of rent growth. John talked about that in an earlier comment. A year, 1.5 years ago, we were still seeing rent increases in the U. S. In the 4s, 5s, 6s, 6% range, 7% range year over year in some select markets. And those 5%, 6%, 7% s are now 2% to 5%. So the rent growth is definitely decelerated. So you sort of look at that combination of factors, again, coupled with interest rates and everything. And it sort of feels like pricing should be coming off the boil. But like I said, the expectations between buyer and seller are still different, I think, which makes it difficult to get deals done. Your next question comes from Dean Wilkinson with CIBC. Please go ahead. Thanks. Good afternoon, guys. On the Acadian portfolio, year to date, sweet turnover 8.8%, obviously a low number. I'm assuming that is trending lower. How does that number compare to the first half of the year going back the last couple of years? I don't have that in front of me. I'm not sure if we have that number in the room, but it definitely I can tell you for sure without quoting a number, it's down. It's down. And that's just purely a function of and again, a lot of our understanding that a lot of our Canadian portfolio is located in the Greater Toronto Area. It's just such a tight rental market, right? So we're seeing big rent increases on turnover and we're seeing lower turnover just because there's less options. And it's also a function, obviously, of the housing industry here in Toronto. Housing shortage, rent control, all the rest of those things. Yes, like that whole basket of circumstances just sort of leads you leads one to understand that easily that there's just less turnover and that people have less affordable options to look at, whether they want to rent a condo or buy a condo or buy a house or buy a townhome. The options the affordability of the options just aren't great. So, we're just finding that people are sticking around longer, which isn't necessarily a bad thing. But again, in the Canadian landscape, on turnover, when we can get 8% to 10%, you're hoping for that turnover. So yes, it's definitely down just for those reasons. Tim. Would there be a little more of seasonality, say, in the back half of the year that turnover picks up a bit? Like or would you think that high single digits might be the world that we're in? Yes, I mean, it'll typically, it'll pick up a little bit just with August being the back half of summer, family is getting settled for schools and stuff like that, it tends to be more quiet than it will pick up a little more in September, October, then obviously you get into the winter months where it declines. So I think Industry issue, right? Yes, industry issue, I think everybody sort of my understanding is everybody sort of seeing the same thing we're seeing. Whether high single digits is the new norm, I can't really comment on that. But I would say it's definitely down. The trend is definitely in that position. Yes, that's going to be the reality, at least for the next little while until some of those other circumstances change. I'll ask Sanjay maybe to add any other color or commentary to that that it can be. Yes, Paul, thank you very much. And you very well explained that's exactly what we are noticing and experiencing in portfolio wide as much we expected to be higher, people are not moving out because of the reasons Paul mentioned. But every time any of the suites which are turnover, we're achieving over 9%, 9.5% to 9.8% increase in the rent. So we're just doing whatever we can to keep on bringing that up. But you're right, it's in some new digits right now. Yes. Okay, good. Thanks, Sanjay. And I don't even know if I understand what I'm asking here, but I'm going to ask it. The Tax Cuts and Jobs Act, so you've got $3,500,000 of unutilized interest expense deduction that they can't what does that mean? Or does do we even need to because it's something that just we can ignore? I mean, at the end of the day, it's a major implication. And I'm like, I'm not going to get into the deferred tax side of it. I mean, I'm an accountant myself, so accountants love that stuff. But the deferred tax, it's you're just setting up the liability for future tax on something you may never sell, right? So if you leave all that aside, the major implication of the REIT is like we have a bunch of taxable subsidiaries in the U. S. We don't pay any tax because we don't have any taxable income in the U. S. Right. And we don't foresee that changing for several, several years. We forecast this stuff out obviously over the long, long term. And the major implication of the change in the tax reform in the U. S. Is that the corporate tax rate has gone down from something like 35% to 21%. And that's important if you're taxable, but again, we're not You could shelter it, so it doesn't matter. So you'll just have this unutilized expense offset that you won't need anyway. So okay. Yes, exactly. All right. I got it. I'm assuming it's probably a little too early to talk about the 2019 debt maturity at this point? Yes. Those ones don't roll till late in the year. I think it's December. So yes, those are more than a year out. So yes, too early to be talking. I'm not sure what's going to happen with banks rates between now and then. But yes, those really are the next rollovers for the REIT and they don't happen for over 12 months. It's a good way to lose away. Okay, thanks guys. That's it for me. Thanks. There are no further questions at this time. Please proceed. Okay. Thanks, everyone, for joining the Q2 conference call, and we look forward to Q3. Thank you. 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.