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Welcome to the European Residential Real Estate Investment Trust First Quarter 2024 Results Conference Call. My name is Carla, and I'm going to be coordinating your call today. [Operator Instructions] I would now like to hand you over to Nicole Dolan, Investor Relations. 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 results and the financial and operating results of ERES, which are subject to certain risks and uncertainties. We direct your attention to Slide 2 and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Kenney, Chief Executive Officer.
Thanks, Nicole, and good morning, everyone. Joining me this morning is Jenny Chou, our Chief Financial Officer; and Karim Farouk, our Managing Director. Let's turn to Slide 4 and get started. Strong operational performance has steadily reinforced the ERES platform since inception, and we're pleased with another on-track quarter. Our residential suites were 98.5% occupied on March 31, 2024. This is consistent with the previous period as we're continuing to keep certain unoccupied suites offline to either enhance value through renovation or potentially sell as part of our optimization strategy. Our occupied average monthly rent was EUR 1,068 at current quarter end, representing an increase of 6.7% versus the same property portfolio on March 31, 2023. Once again, this is above our target range of 3% to 5%, reflecting the tight rental conditions in the Dutch housing market, which are showing no signs of softening as well as ERES' ability to maneuver within its complex regulatory framework. Turning to Slide 5. I'll provide a brief update on investment activity during the first quarter. We're pleased to have closed on 24 single suite dispositions during Q1 for combined gross proceeds of EUR 7.6 million, which represents a strong premium to the previously reported IFRS fair values. Subsequent to period end, we sold an additional 42 suites for an aggregate consideration of EUR 10.8 million, excluding transaction costs, which is again in excess of fair value. We're excited to be accelerating our progress on this strategic initiative, and we'll continue to ramp up our efforts in order to generate incremental capital primarily to pay down our credit facility debt and sturdy our future financial position. On our investment portfolio, fair value decreased by 0.5% this quarter to EUR 1.67 billion. Persisting inflationary and interest rate pressures, alongside political and regulatory uncertainty in the Netherlands, drove up the portfolio's implied calibration. However, this was offset by higher forward NOI. The residual change in fair value was due to individual unit sales, all in all. Our diluted NAV per unit remained relatively stable at EUR 2.89 at March 31, 2024. I'll now turn things over to Jenny to walk through our financial performance.
Thanks, Mark. Slide 7 summarizes our financial performance for the first quarter of 2024 versus Q1 of 2023. Strong rent growth and high occupancy increased operating revenues by 4.5%. On the expense side, property operating cost decreased as a percentage of revenue, and together, our NOI grew by 7.1%, while our margin expanded by 190 basis points to 78.2%. The strong organic growth continues to mitigate the impact of higher interest rates that we're absorbing. And our diluted FFO per unit of EUR 0.039 was relatively flat versus EUR 0.040 in the comparative period despite the elevated interest costs arriving from our mortgage financing in June of 2023. Our annual rate of distribution was held steady at EUR 0.12 per unit, and our AFFO payout ratio was 80.8% for the current quarter, which is within our long-term target range. Referring to Slide 8, we continue to proactively and prudently manage our liquidity and leverage. Our adjusted debt to market value ratio was 58% as of March 31, 2024, which is consistent with the previous quarter. In addition to our current debt service and interest coverage ratio of 2.4x and 2.9x, respectively, we remain in compliance with all of our covenant restrictions. On our mortgage portfolio, as displayed on Slide 9, during the quarter, we renewed one of our commercial mortgages for an additional 3-year period ending on March 27, 2027, with EUR 18.7 million in principal and a fixed contractual interest rate of 4.7%. This increased our weighted average effective interest rate to 2.22% at period end, which remains low in comparison to current rate. This is due to the fact that at period end 100% of our mortgages were by net returns and arrangements that result in fixed interest payments. We also mitigated our interest expense volatility risk through setting a renewal as you can see on the slide. Moving forward, we'll continue to carefully and optimally manage our platform, financial structure and liquidity to enhance cash flow, maintain balance sheet flexibility and mitigate the impact of future mortgage maturity. I'll turn things back to Mark to wrap up.
Thank you, Jenny. On Slide 11, we summarize the ways in which we're currently enhancing returns for our unitholders. This includes our tried and tested rent growth strategy comprised of uplifts on turnover, indexation and the conversion of regulated suites to liberalized. This is augmented by the opportunity for suite-by-suite privatization. And we're evaluating the net present value of reletting an individual unit versus selling the units to end users. Beyond this, we're also continuing to explore additional opportunities to optimize our business and generate capital, with a view to ensuring we're ultimately maximizing value for our unitholders. That brings me to our investment highlights on Slide 12. The end of the first quarter of 2024 marks the 5-year anniversary of ERES. We're proud of the progress we've made to date, and we'd like to thank all stakeholders for their long-standing support. Looking ahead, we'll continue to execute our strategic, financial and operational objectives as we reaffirm our active commitment to driving incremental value for our unitholders in all the ways we can. With that, I would like to thank you for your time this morning, and we would now be pleased to take any of your questions that you may have.
[Operator Instructions] Our first question comes from Jonathan Kelcher from TD Cowen.
First question, looks like you picked up the pace of sales post the quarter, selling 44 versus 24 in Q1. Is that just seasonality? Or what sort of volume roughly do you think we can expect for the year?
I think it's probably more attributed to the ramp-up of the program. The offering to existing residents does take 90 to 120-day cycle to kind of come to light. I would say, looking forward, we remain very focused on optimizing value in any way possible, whether it be unit sales or other. And we're happy with the progress we're making on unit sales. This will be a permanent part of the strategy, but it's not limited to individual unit privatization. We continue to be open to all means of servicing value for ERES unitholders.
Okay. I would take that to mean you're also looking at selling buildings. Do you have any -- like what's the market like right now? Do you have any listed for sale?
Activity is still relatively low. I would say that not unlike North America, there was a burst of enthusiasm followed by a pause when rates kind of went a bit wonky on the tenure. But I would say the overall messaging we're hearing from brokers, we're hearing from appraisers, and we're hearing from peers on the Street is the outlook obviously is quite positive for lowering rates, and that will be extremely positive for apartment valuations to transaction volumes.
Okay. And then just lastly, the CapEx in Q1 was down quite a bit. Is that a timing issue or any change in strategy?
No, there's a change of strategy. The market has become so strong that we are really trying to find that delta difference between what the market gives you on a rent increase on turnover versus what you get with full renovation. And with the cost of our capital having risen so much and our focus on paying down debt, we're very pleased actually with the net result of what we're now doing. The team is working very hard to optimize those rents with the renovation program. And we have seen that just in the marketplace, not unlike Canada, the Netherlands is just right in the middle of a housing crisis or perhaps at the beginning of a housing crisis, and it's just not necessary.
Okay. But the math still works going from when you have the opportunity to go from regulated to liberalized, correct?
Yes, that strategy hasn't changed.
Okay. So it's just like less spend on, say, liberalized, to go from tenants.
Liberalized, yes, that's right. That's right.
Okay. And is Q1 sort of a good run rate for CapEx?
And Jonathan, just to add, there is a slight timing issue, too. Q1 typically for our non-in-suite is typically on the lower end. So it's 2 things. On our in-suite, I would say Q1 is probably a good run rate. But for the non-in-suite, we should be seeing a higher number than Q4.
But it's not a seasonal effect, yes.
Yes.
Our next question comes from Kyle Stanley from Desjardins.
Just building on Jonathan's question there. So I just noticed the uplift on turn was a bit lower this quarter. So is that part of this strategy shift where like specifically on the conversion to liberalized, I think it was about a 35% increase, which obviously is still fantastic. But a little lower. So is that just less investment? Or is that just suite mix?
That's completely a result of less investment and reaping the reward of just the strong market on the fundamentals of the strong market alone. You do know that -- yes...
Yes. No, I think that makes perfect sense. Then the other thing I was thinking about here, so the cadence of your mortgage maturities for the balance of the year, I think, obviously, pretty limited, but just curious on the timing of those.
Yes, we have 18 -- sorry, roughly EUR 40 million that sort of that we just [ lost ], that we've disclosed. And then the remainder of that is all in Q4.
Okay. So very year-end weighted.
Yes.
Okay. And then the last one for me. So I think you gave some disclosure in your prepared remarks about how the disposition prices compared with IFRS and they were at a premium. I think last quarter, you mentioned, maybe not comfortable disclosing that yet, but you would kind of going forward. So just curious if there's any update there? Or is it something that we can look forward later in the year, maybe for more disclosure?
It's not something we are contemplating on the disclosure front, but I don't mind giving some color as to why. When you look at the IFRS values, it doesn't take into a unique attribute of each individual suite. And so when we're selling to residents and selling individual units, it could be misleading in terms of the overall mark-to-market evaluation. But let's leave it to say it's very strong double digits beyond the valuation.
Our next question comes from Dean Wilkinson from CIBC.
Just one question for me. One question for me, Mark. When you're -- and this might be a hard one to answer. When you're selling one of these units to your residents, do you have a sense of what the average differential would say be from them to carry sort of a mortgage at some assumption versus rent, trying to get a gauge of what that affordability gap is and how that could look going forward.
No is the short answer, because I think the decision by residence to buy is highly predicated on the value that they're buying the unit at versus what they perceive the value to be buying in the current market around them. So there is a differential between what they're able to buy for and what might be readily available in the market. But really more -- Dean, I think, is playing into it is obviously the convenience of not moving and staying in your own home. But also the -- if you look at what's happening to housing prices in the Netherlands, it's not unlike Canada, they're just on a continual rise with no signs of slowing down. So I think folks are actually just saying, look, I'm going to be here for the long run. I have a chance to buy my home. It's highly accretive for ERES to do a disposition and probably a very good deal for the resident to not have to move and be able to buy something at perhaps they see as a slightly discounted value in the local market. That's what we're hearing is that, yes, they like the value, they can see the value and both sides are happy.
All right. Maybe asked another way, at like EUR 276,000 a door average that you've kind of done the 66 in the last 2 quarters, is that materially less than if say, I was there, and I just wanted to go out in the market and look for something. Would this be sort of a 20% differential? Or is that another hard one to gauge because the product is very different?
Well, the valuations take into consideration those market values, and it's a little bit crude how they do it, and they don't take into account the valuation for all units going to market. They take into evaluation a privatization strategy of 10% of units turning over. So that's already baked into the valuation. But like I said to Kyle, what we're actually achieving above those valuations is well into double digits. And that's why for ERES, it's very attractive. And obviously, it's for the residents buying their units or for those turnover units, also attractive valuation. They're selling quite quickly.
And Dean, just to add to that, all the units we've been selling, not all of them are to tenants. It was like -- around half of them are actually vacant units that we sold to a third party where we just put out in the market. So those would be at market price.
But [indiscernible] price to allow for a quick take up, yes.
Yes. No, you kind of get the math, right? It looks like it's about a mid-teens premium to where you might be carrying maybe 20% to where sort of people are carrying the NAVs, and if we could buy homes in Canada for under EUR 300,000, then all our problems will be solved.
Our next question comes from Sairam Srinivas from Cormark Securities.
And my apologies if these questions have already been addressed at the call. I was a little bit late to the call. Mark, can you just talk about the commercial portfolio for -- the decrease in rents that you saw there this quarter. Is there some color behind that?
Yes. It really relates primarily to the renewal of our lease in Belgium. And I'll let Jenny speak to that a bit.
We did have a new lease renewal in our Belgian property. So that's the single-tenanted building. It was the long-term lease that we entered in pre-COVID. And obviously, with the decrease in market rent, when it's time for a renewal, it was a sizable decrease to our previous rent.
It is a long-term government tenant. So the cash flow will be exceptionally stable now. But as Jenny said, market here or even in office, they're just like we see in North America.
Good color, Mark. And the last question I had was on operating expenses. Obviously, you guys made good progress this quarter in terms of decreasing those. But is that a function more of timing? Or is that more to do with general reduction in these expenses overall?
Yes. I think in general, the focus for the team has been on scarcity of capital that's available. They're pushing very hard to find efficiencies. ERES was in rapid growth mode and stabilization mode for a few years there. We've had a pause on that. And it would just be attributed to good, old-fashioned efficiency.
[Operator Instructions] Our next question comes from Jimmy Shan from RBC Capital Markets.
So just on the suite sales done so far, what would the cap rate look like on trailing NOI?
The impact or on the price paid?
Yes, if you take the price, the proceeds that you got and when you look at the NOI on a trailing basis, what would that show?
You're -- it's like trying -- basically, you're trying back into the premium to IFRS.
No, I was just trying to get a sense of how far -- how wide it is from the transactions.
Yes. Significant double-digit increase over IFRS, and we can walk through the math maybe a little bit more in detail of [indiscernible].
I'm just assuming that those are -- the rents would be higher, I would imagine, on those assets, and that's why. I was trying to determine if like there's a big variance. I mean, you don't have to provide a specific number but just sort of a range.
Sorry, Jim, what do you mean by the rent would be higher? Like, are you saying like of all those units that we're selling?
Yes, or even the size of the unit, maybe because I'm on the assumption that they're more townhouses?
Yes. Okay. So yes, the focus of sales has been on the single-family home or townhouse product. That's where there is the most demand. So yes, the size of units would be bigger. Therefore, the total revenue would be bigger. But the cap rates for those units are no different than the rest of the portfolio. So I don't know if that answers the question or not.
Okay. That's fair. And then maybe generally, like based on your discussion with brokers, what are they telling you in terms of cap rates that it would take today to move a property today?
Well, ERES is in no hurry to sell assets. There is a market that is out there, no doubt. Family offices are still very much interested in privatization strategy for buildings. Those single-family homes would be in high demand. We are always open to servicing value for ERES unitholders in any way possible, but we are in no rush to do that, and we will not compromise value in the process. What we have said previously is that we are obviously very aware of maturing debt and very focused on the strategy to mitigate any negative effects there. But I would leave it that we're extremely well connected with local brokerage and what's happening in the marketplace, and we will be opportunistic to plow into that market if strong bids show up. That's always, no different than many of our peers.
Our next question comes from Brad Sturges from Raymond James.
Just one question on the mortgage financing that you did so far this year. It looks like both mortgages were related to the commercial portfolio. The one, specifically post quarter, that was a 1-year extension. I'm just curious if you can give us a little bit more color in terms of which asset that was and the thinking around the 1-year extension.
It's the German property.
And is it just because there's still -- there's like a shorter [ work ] left and there's some leasing to do? Or what's the thinking around the 1-year extension?
Yes. It is just to do a short-term extension while we're improving the leasing on it so that when we do a full long-term renewal that can be more meaningful.
And that was our final question. I will hand back over to Mark Kenney for final remarks.
Thank you, operator, and thank you to everyone for joining us this morning. If you have further questions, please do not hesitate to contact us at any time. Thank you again, and have a great day.
And this concludes today's call. Thank you for joining you. You may now disconnect your lines.