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Hello, everyone, and welcome to the European Residential Real Estate Investment Trust First Quarter 2023 Results Conference Call. My name is Nadia, and I'll be coordinating the call today. [Operator Instructions] I will now hand over to your host, Nicole Dolan, Associate Director, Investor Relations, to begin. Nicole, please go ahead.
Thank you, operator, and Good morning, everyone. Before we begin, let me remind everyone that during our conference call this morning, we may include forward-looking statements about expected future events and the financial and operating results of ERES, which are subject to certain risks and uncertainties. We direct your attention to Slide 3 and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Kenney, Chief Executive Officer.
Good morning, everyone. I'm pleased to be joining you today. With me is Jenny Chou, our Chief Financial Officer. As this is my first conference call as the CEO of ERES, I'd like to start by looking back on the REIT's 4 years of strong performance. Looking at Slide 5, ERES has beginnings when we entered the Netherlands back in 2016. From this point, the company grew exponentially leading to the creation of ERES on March 29, 2019, with an initial 2,091 suites. Today, ERES remains Canada's only European-focused residential REIT. We own approximately 6,900 residential suites well diversified across the Netherlands.
About half of our properties are located in the high-growth Rand stat region and the remainder in other strong more suburban markets. We are also split with 2-thirds of our portfolio being nonregulated. And on top of that, one-third of our portfolio is comprised of single-family homes, also known as Dutch Row houses or what we commonly refer to as town houses here in Canada. On Slide 6, you'll see ERES' first quarter snapshot. Our closing unit price was $3.325 at period end, which remains below our NAV per unit of EUR 4.91. This provides investors with the opportunity to capture what we consider to be strong value play, and it also provides investors with one of the highest distribution yields in our peer universe.
Strong rental demand in the Netherlands has driven consistent rent growth for ERES as you can see on Slide 7. Since inception, we've achieved a constant annual growth rate of 4% in occupied AMR, which is at the upper end of our target range. In the first quarter, occupied AMR grew by approximately 6% on the same property residential portfolio. At the same time, occupancy remained high and stable at 98.7%. On top of this, about 3-quarters of our residential vacancy is intentional as we temporarily keep units off-line and turnover in order to further invest in value-add upgrades and renovation. This improves the quality of our suites, the enjoyment of our residents and our future operational and environmental performance.
Importantly, ERES has been accomplishing these strong operational results within a fluid and uncertain regulatory regime. In fact, this represents one of our primary competitive edges. We have a deep understanding of the regulatory framework, but we also are strategic, adaptable and experienced at working within changing parameters. Turning to our other quarterly updates provided on Slide 8. As you can see, I am presenting this to you today in my new capacity as CEO of ERES, which became effective at the close of Q1. I'd like to acknowledge my predecessor, Philip Burns for his strong leadership throughout the REIT's first 4 years.
Other significant developments for this past quarter include a $25 million increase in our credit capacity, which Jenny will speak to shortly. On the valuation side, the fair value of our portfolio decreased to $1.7 billion at March 31. This was mainly due to [indiscernible] expansion in the Dutch market, partially offset by higher forward NOI on our portfolio. Our diluted FFO per unit was EUR 0.04 for the quarter, trickling into an AFFO payout ratio of 85.2%, which is right in the middle of our long-term target range. I'll now turn things over to Jenny to go through our financial results in detail.
Thanks, Mark, and Good morning, everyone. Slide 10 provides our financial performance in Q1 as we compare to the same quarter last year. Operating revenues on the total portfolio were up by 10%, a result of acquisitions and the strong same-property AMR growth, which Mark highlighted earlier. Our NOI margin was 76.3%, including service charges, which is down by 0.5% due to higher R&M and advertising costs, partly offset by lower landlord let we expect. On a stabilized basis, NOI margin was down for similar reasons, but to a lesser extent, was a 0.2% decline to 76.6% for the first quarter. Combined with higher interest costs, which we are absorbing on our mortgage portfolio and credit facility as well as increased current income tax expense. Diluted FFO and AFFO per unit both decreased by approximately 5% compared to the first quarter of 2022 that remained flat compared to Q4 of 2022.
Inclusive of our distribution hike which became effective last March, our AFFO payout ratio increased to 85.2%. On Slide 11, you can see that we continue to maintain a firm financial structure. In fact, we fortified our liquidity position this past quarter by increasing our capacity on our revolving presence lease by EUR 25 million plus an additional EUR 25 million accordion feature. Due to the fair value loss on our investment properties this quarter, our ratio of adjusted debt to portfolio market value decreased to 54% or increased to 54%, which is built significantly below our covenant threshold. Our other debt metrics also remains conservative with consistently high coverage ratios that are safely within guidelines.
Finally, Slide 12 displays the well-staggered disposition of our mortgage profile, which provides an invaluable safeguard in today's volatile interest rate environment. 100% of our markets are financed with terms and arrangements that result in fixed interest payments. We also have a very low weighted average interest rate of 1.77% of the total portfolio. With less than 10% of our mortgage debt maturing both this year and the next, we are well positioned to withstand further macroeconomic adversity in the coming years. I will now turn things back to Mark to wrap up.
Thanks, Jenny. Looking at the chart on Slide 14, you can see that the Netherlands has been experiencing significant growth in this population. Although it's currently peaking with the rise in immigration due to a post-COVID catch-up and the war in Ukraine, it is forecast to stabilize at elevated levels. This population growth has been driving increasingly strong fundamentals in the Netherlands, which is already the most deathly populated country in Europe and one of the most densely populated countries globally. As a result of its growing population and lack of buildable land, there is a severe national housing shortage, and that is expected to increase again this year. In order to meet projected Dutch housing demand, it is estimated that a target 100,000 residential units must be built per year over the next decade.
However, you can see on Slide 15 that over the past decade, the Dutch haven't even come close to building 100,000 homes per year. And indeed, it is a very challenging target. The number of building permits for homes is lagging, while construction costs and personal - personnel shortages remain high. As such, forecasts generally don't predict that the Netherlands will be able to meet this target. On the whole, this locks in those strong fundamentals for the long term, which continuously growing demand for accommodation is present in the country.
And that brings me to our final Slide 16. We believe the future for ERES is full of opportunity, and I am very excited to be leading it forward as we build on its strong track record established today. Our fundamental mission remains the maximization of value for all ERES unitholders. Moving ahead in 2023, we will continue to actively work on doing just that. On this note, I would like to thank you for your time this morning, and we would now be pleased to take any questions that you may have.
[Operator Instructions] And our first question goes to Sairam Srinivas of Cormark Securities.
Good morning, Mark, Jenny. Thank you for your opening comments. Just looking at the regulations that came out in Feb, and it's been some time since then, how has the market digested that? And what's the reaction of the broader estate community out in the Netherlands in terms of how this housing supply price is going to be solved over there?
Are you talking about the general market fundamentals of valuation? Or are you talking about the fundamentals of operating metrics?
More from an operating perspective, Mark, in terms of the regulations that came in, are developers now seeing -- are they more reluctant to kind of even add more supply into that market? Or how have they generally received the new regulation?
Well, I think in the presentation, I made brief reference to quite a severe decline in building permits, very much like what we're seeing in Canada and elsewhere in the world. The housing shortage is absolutely confronted with these realities, higher interest rates for development debt, higher costs on the construction side for both hard and soft costs and a very slow environment to get permitting. So gate one of this, just like Canada is the permitting process, which has fallen off a cliff. If the permitting process has been stacked with interest. I would say there's a chance for the next 2 gates to be open, but it's not looking very positive at all on the supply front.
That's good color, Mark. And just only on that note, are you seeing any transaction activity in the market? I know capitalization rates were a bit high this quarter. Is that a reflection of a weaker transaction market in Europe? Or is that more asset-specific?
There is [indiscernible] a very - a lack of transactions. In all of the Netherlands.
So I would -- I thought this would be definitely the first question, and here it is. When we're doing the valuation exercise, the thing I want to really highlight is in the Netherlands, there was one 64-unit building that transacted in Q1. And other than a 64-unit building, I think there was 18 units that were socialized housing, and the building was bought by a housing association. So in terms of market clarity on where valuation sits, it's completely unclear.
You know, valuators have no other option but to draw out a curve when there's a lack of information. But on top of the lack of trade, there's been a lot of sideline activity in the Netherlands. First, because of a rising interest rate environment, there appears to be more clarity on now; and second, clarity on a new rec, okay? And the new rep was established, and that was going to potentially have effects in the market. I think a lot of market participants have been on the sidelines waiting to see the effect of that.
So you've got a couple of dynamics happening there. What we're also seeing, in general, in the marketplace, as we have discussed in the past, virtually all -- not entirely all but a large share of the apartments in the Netherlands are individually freehold title. And what we are seeing is a lot of the apartment investors selling their units into the general market. And with the regulatory overhang with interest rate concerns, you're seeing the actual rental market in the Netherlands get much, much smaller. So in fact, there's a rising demand dynamics, but an ever-decreasing inventory of available rental.
The next question goes to Jonathan Kelcher of TD Cowen.
I guess just sticking with that thread, 2 sort of follow-up questions. One, first on what are the brokers saying in terms of expectations for properties to come on to market over the rest of this year?
I'd say the volume in the Netherlands on properties coming to market is a little bit higher than what we've seen in Canada. We still see in Canada, virtually very, very few listings. I was just there on the ground, met with brokerage community, and there is definitely talk of more product coming to market. I think you've got leverage owners that are facing the reality of higher interest rates. But I think the general theme that really struck me was that there are a lot of owners -- individual owners leaving the marketplace and selling their units, which again is back to what I just said in the last point. And it's -- I guess it's appropriate, Jonathan, at this point to note that there is some attribution to privatization that's embedded in the valuation, but anybody will tell you it's not building specific, and it's market generalized.
So we think that there's incredible embedded value in the privatization of the individual units. Now I wouldn't use that as a marker of change for the direction of the company, but it's definitely something that we're exploring. We can't help but explore it given our Randstad presence and given our [indiscernible] presence, which is actually extremely highly weighted in the ERES portfolio. So I just think that there is caution should be given when looking at our NAV because we think, if anything, the appetite for individual privatization units is getting stronger and stronger as no supplier - little supply comes to market; meaningful supply at least.
Okay. So would you look at -- I guess you are looking at selling some individual units into the market. And I guess that would just be to sort of reduce the strong on your line?
Yes. My -- this combination of exercises delevering, especially in the case of ERES, I think, is something that must be looked at. So it's just a matter of looking at our lowest cost of capital and pursuing that end. But my role as the CEO of ERES is to maximize value for unitholders using any possible measure available to me. So I think what I'm trying to message here is everything is on the table in terms of maximizing value for unitholders and the privatization of units is definitely something that struck me when I was over there as being an opportunity that ERES can pursue and look at more deeply.
Okay. And then just one last - one last question for me. The -- I noticed post the quarter that ERES repaid capped the $26 million cap REIT note. Was that through a new mortgage? Or is that on the ERES credit facility now?
It's currently on the credit facility, but it will be paid down using our mortgage proceeds that we're expecting to receive at the end of June.
Okay. And what sort of rate would you expect on that at the end of June?
Mid- to high fours.
The next question goes to Brad Sturges of Raymond James.
Just to go back to the discussion on privatizing units. If you were to execute that on the row houses, is that potentially are you exploring across the portfolio? Or would that be by -- are you more interested in certain regions where that makes potentially some sense?
Well, the interesting thing about the Netherlands is that every unit that turns over, an analysis should be done on deciding whether letting value or sale value represents the greatest value for unitholders, okay? So at a very minimum, every unit that turns over we should be looking at. Next to that, there is government incentives given to first-time homebuyers and there is the ability to sell to our existing tenants. So once we perform a proper analysis where NAV can be greatly enhanced by privatization of individual units versus perhaps a sale of a building or other means. We will 100% be looking at every possible option to maximize value, pull in equity, pay down this short-term debt problem and get through to the other side.
Okay. That makes a lot of sense. Just on, I guess, the operating results of the quarter. I think turnover rate was a little bit higher, but I'm assuming you still expect that to normalize to the kind of the traditional range for the rest of the year?
Yes. Q1 is probably on the higher end. I would expect it to be more so in 10% to 12% range for the year.
We're certainly encouraged by the opportunity to get at some of these unregulated unit rents. So that's a positive. And that positive, I think, will only be augmented by this exercise of truly bringing knowledge to market on the true embedded value of the portfolio.
Is there anything specifically that would be driving a little bit higher turn or churn, I guess, in the quarter? Or is that more kind of seasonally expected?
I - you know what, I think it's one of these anomaly things. It's not dramatically higher, its slightly higher. There's a lot of COVID rebalancing effects. The war has effects that we see in North America in the Netherlands. And yes, I wouldn't read too much into it at this point. We don't have anything sort of schematic to describe why it was elevated.
The next question goes to Himanshu Gupta of Scotiabank.
Just on the transaction activity, Mark, have you listed anything for sale in the market in the last 3 months? And if yes, how is the response been?
Yes. I can't comment on that, Himanshu. But all I can say is that I am fully dedicated as the CEO of ERES to maximize value for unitholders using any means available to me at all. So with that, we include potential listing buildings. If deems appropriate, no different than my prior experience or ongoing experience. If we can get higher than NAV valuation that's significant and noteworthy, we are absolutely open to selling assets. And I think that, again, getting kind of into the weeds here, there's an interesting dynamic that's emerging in the Netherlands with housing associations.
Because of the affordability crisis that they are also experiencing, we are hearing of housing associations getting back into the market of acquiring existing properties. And it's hardly a trend with 164 unit building trades in Q1, but it is noteworthy that it was a housing association. So if the government strengthens its conviction on affordability, which it is in the Netherlands, I wouldn't be surprised to see a lot of activity with housing associations trying to get portfolios back in the mix to help maintain affordability.
Got it. That was helpful, Mark. And maybe on the same line, as you kind of take charge of ERES, what will be your top 2 or 3 priorities for this year? I mean, obviously, you mentioned everything is on the table and looking at everything, but any specific 2 or 3 priorities you have for the rest of the year?
Well, the operating metrics of the company are excellent. Like the performance is great. I spent a little bit more time than normal on fundamentals because I'm really trying to get proper recognition of how very, very strong rental fundamentals are in the Netherlands. But like the rest of the world, the current topic of the moment is debt and the topic of the moment is the cost of debt -- so certainly, we're keenly aware of that as a distribution vehicle.
We are in excellent condition on the balance sheet front. We have no concerns whatsoever with weathering the conditions that are there. But where there's opportunity to get valuation above what's recognized on our books and use that equity in the lowest cost of capital way to pay down debt, we will absolutely do that. That's been the tried and proven strategy that a lot of successful companies are employing it there right now.
[Operator Instructions]. And our next question goes to Jimmy Shan of RBC.
So just to follow up on that privatization of units discussion. Have you done any such letting versus sale value analysis on any particular units? I imagine it's pretty relatively simple desktop analysis you could do and kind of wonder what you've seen so far in terms of the delta between those 2 values.
Well, when I went to the Netherlands, there's been -- I think we've transacted on 4 units. So I would call it a meaningful impactful effort to date. There's a little more -- just assume every unit is individually titled that can be sold tomorrow. You've got the existing tenant market, and you've got the vacant possession market. So the balancing act, Jimmy, is you've got this regulatory effect coming in. So units that fall into the new net of the regulatory regime, it's very, very possible that those units have a much higher privatization value, then they have letting value.
So that consideration number one. Consideration is giving to our existing tenants, residents, I should say. And the next consideration is given to looking at assets that we want to sell down in slowly over time. So it could be 100% owned rental asset will maintain a better value than something that we swiss-cheesed to 90%. So we have to give some thought to that. And then on the [indiscernible] side, which I can't say enough of, that's really less of an issue.
So we have to give some thought to where we want to start the program to kind of dilute but pull out unbelievable value. And when the unbelievable value is presented there in our analysis, we'll look at doing it. So a bit of analysis on letting value versus privatization value on turnover, a further analysis on their first-time homebuyers are concentrated where we can again get higher privatization value and then other strategies around assets that we can sell well above NAV. So all of these things are on the table to deal with in a balanced way to manage our debt situation, to delever and to be well positioned to grow again when the market finds calm.
Okay. And then as far as the asset value that you have in the books today. So, the -- given the lack of transactions, as you mentioned, how did you come up with that value? What was some of the reference point that you use to arrive at this revised value?
Well, okay. So let's do -- as you probably have heard me say many, many times, as an organization, we take a very conservative approach to things like NAS. We always want to be ahead of gyrations in the market. The valuators, we respect the process. This is an independent exercise, okay? I would say that what we heard from the valuators was we had this rep issue sitting on the sidelines that had more clarity given to us. And without comparatives, they have to make assumptions on how an increased rep could affect valuation.
Whether that's right or whether that's wrong, I'll leave that for the -- for you to digest. But we respect the valuation process. There are some calculation issues that showed up in the marketplace. They haven't really revealed anything as of yet, but we follow the path of the valuators. The point that's subtle and the point that really needs to be digested and we haven't given enough transparency on this yet because we're gathering information. Is in that valuation exercise, like I said, there's some attribution made for privatization, but it is by no means a comprehensive review of privatization value.
And valuators say that. They look at the market in general, they don't look at the volume of 2 bedrooms versus one bedroom or renovation or anything like that. They look at the generalized marketplace, okay? And they put some form of value because this is the traditional model of how to operate an apartment building in the Netherlands. You let and you sell, you let and you sell. And it's a combination of both letting return and privatization of individual unit return that the broad-based market uses in the Netherlands.
So evaluators understand this. So for that reason, they -- you get a slightly lower cap rate to recognize some degree of privatization. We hold a view very strongly on very limited information. There is quite a disconnect between that number, of what's in the valuators report, and the actual number that can be achieved when you're picking the right units.
Okay. Okay, great. Maybe just one last one. In terms of the mortgages, can you remind me, is there an asset value test with respect to the mortgages?
Yes. I think they're - as in our existing mortgage Jimmy or you mean the one that we're entering?
Existing, the existing mortgage.
Yes. There's a sort of a hard cap at 50%. And we're not anywhere near it.
Okay. 50%.
Yes, because it should be on the mortgage. So yes, we have like our debt to LTVs at 54, but that includes our credit facility.
Right. Okay. So but on the mortgages themselves, it'd be 50% and I guess I can calculate. So you guys are lower than that. And the value will be based on what value, the value that you report, I guess is part of the part of the IFRS reporting? Or is it their -- who comes up with the value?
It's a mix. Sometimes they rely on our valuers. Sometimes they would get their own independent evaluation.
Thank you. Our next question goes to Gaurav Mathur of IA Capital Markets.
Just a quick question on the cost of financing on 5-year money. Could you talk about where you're seeing that at the current - currently?
Yes. We're -- it's similar to what I was mentioning before. Five-year money would be roughly in the mid- to high 4s right now.
Okay. Okay. Great. And then just one last question for me. With the suites and the turnover rate that we're seeing, how are you thinking about the CapEx spend keeping in mind the mid-market regulations?
Yes. We've eased off on our renovation program. And it's actually a great question, we didn't touch on it. But that, in fact, does add a little bit of repairs and maintenance pressure. When we're not doing capital expenditure in suite, we're doing some minor but accelerated repairs and maintenance work in place of that. So we're really pulling back just given the general market dynamics of the unregulated units, and that hits up a little bit of an R&M effect as well. But not coming, it's already embedded in the Q1 results. So we expect much of the same trends going forward.
[Operator Instructions] We have no further questions. I'll now hand back to Mark for any closing comments.
Thank you, operator. And again, thank you for joining us this morning all. If you have any further questions, please do not hesitate to contact either of us at any time. Thanks so much.
Thank you. This now concludes today's call. Thank you so much for joining. You may now disconnect your lines.