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Good day. My name is Karen, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the European Residential Real Estate Investment Trust Second Quarter 2023 Results Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions]. I would now like to turn the call 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 events and the financial and operating results of ER REIT, 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 Kenny, 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 begin with our operational results. On Slide #5, you can see that the strong performance continued in Q2. We achieved 6% growth in our occupied average monthly rents and residential occupancy remained high at 98.6%. This excludes the impact of 2023 lease renewals, which become effective on July 1 of every year. Rental increases due to indexation beginning this past July 1, 2023, we served tenant notices to 97% of our residential portfolio, and the average rental increase was 4%. This is up from 3% in the prior year period, which we will see positively impact next quarter's operational results. Slide #6 provides our quarterly update. In June, we secured EUR 76.5 million in mortgage financing, which carries a fixed interest rate of 4.66% for a 6-year term to maturity. On our investment properties, fair value decreased by 2.3% to EUR 1.74 billion. Higher forward NOI was offset by an expansion in the portfolio's capitalization rate to 4.3%. This was a result of ongoing inflationary and interest rate pressures as well as heightened regulatory uncertainty. On the latter, the Dutch government recently dissolved making the proposed regulation of the mid-market rental sector even more uncertain at this time. Parliament is expected to provide clarity on its enactment by mid-September. The depreciation of our portfolio contributed to the decrease in our diluted NAV per unit to EUR 3.15 at June 30, 2023. This remains above the price of our units in the market, which offers value in addition to providing one of the highest distribution yields in our peers' universe, currently at around 6%. We also recently announced that we are undergoing a strategic review process, in line with our active commitment to maximizing value for ERES's unitholders. This remains in progress as we continue to explore every possible avenue to achieve that. I will now turn things over to Jenny to go through our financial results in detail.
Thanks, Mark, and good morning, everyone. Slide #8 summarizes our financial performance in the second quarter. Mark does get our high occupancy and AMR growth and that drove the 7.6% increase in our same property NOI. Further stat, our property operating costs decreased as a percentage of operating revenue, primarily due to the abolishment of the landlord levy tax. This altogether resulted in the expansion of our same-property NOI margin to 79.5%, which is up from 77.1% in the 3 months ended June 30, 2022. In spite of the strong operational performance, FFO per unit decreased by 4.7% to EUR 4.10 on a diluted basis. This decrease is due to the higher interest costs that we continue to absorb as compared to the prior year, along with higher current income tax expense. That said, our diluted FFO per unit was up from EUR 4.0 achieved in the first quarter of 2023. Our AFFO ratio was 79.2% for the 3 months ended June 30, 2023, which is consistent with the prior year period. Turning to Slide #9, you'll see our financial results for the first half of 2023. Total portfolio operating revenues and NOI increased by 8% and 9%, respectively, primarily due to strong rental growth. Combined with lower property operating costs, NOI margin increased by 70 basis points to 77.8%. In the context of continuing high inflation, this also reflects IRES's protection from such pressures. As a reminder, our tenants are responsible for their own energy and other utility costs. The REIT incurs no wage costs and property management fees are a fixed percentage of operating revenues. Diluted FFO per unit and AFFO per unit were down 5% and 3%, respectively, which again reflects the impact of higher current income tax and higher interest on our mortgage portfolio and credit facility. Our 6-month AFFO payout ratio was 82.1%, which is within our long-term target range of 80% to 90%. Slide #10 presents our financial position. We have available liquidity of EUR 190 million, which includes EUR 20 million in unused capacity on our revolving credit facility and EUR 165 million accessible through the REIT pipeline agreement or alternative promissory note arrangements with CAPREIT. In addition to cash, we have on hand. Due to the fair value of decline in our core portfolio, the REIT debt-to-market value ratio increased to 55.7% at period end. We continue to actively monitor our leverage and coverage ratios to maintain compliance with all companies. Finally, Slide #11 displays our well site or mortgage profile. This incorporates our latest financing, which we secured at the end of the second quarter, providing a principal amount of EUR 76.5 million, as Mark mentioned earlier. The new mortgage financing matured on June 26, 2029, and carry a fixed contractual interest rate of 4.66%. Although this increases our weighted average interest rate to 2.07%, it still remains very low in the context of the current interest rate environment. We continue to take a proactive approach with regards to our mortgage portfolio and try to manage volatility risk by fixing the lowest possible interest rate for long-term mortgages. At present, 100% of our mortgage interest costs are fixed. We also mitigate refinancing rigs through managing the portfolio's average term to maturity and by staggering mature meetings. And as you can see on this slide, in doing so, we currently have no mortgages maturing for the remainder of this year and only 9% of our mortgage debt maturing in 2024. I will now turn things back over to Mark to wrap up.
Thanks, Jenny. As we look ahead, we're going to continue exhausting every available opportunity for value creation. Our ability to do that is underpinned by a housing crisis in the Netherlands. It continues to escalate. And as you can see on Slide #13, the evidence is clear. The housing shortage will grow to more than 325,000 homes in 2023 and is expected to increase even further to 400,000 in 2025. The most important indicator for demand for new homes is growth in the number of households. With the influx of Ukrainian refugees, the number of households rose by 150,000 in 2022, which is a significant increase at the average growth is approximately 63,000 per year. In order to address the rising demand, the national government set the objective of building 100,000 new homes per year. However, the number of building terminals fell by 18% in 2022. And unless the government takes incentive measures that is expected to drop even further in 2023 and 2024. The rising demand combined with ever-decreasing inventory of available rental results in very strong market fundamentals in the Netherlands. These conditions lend themselves well to ERES's core purpose as a provider of rental accommodation. In attention to address housing supply and affordability, over the years, the Dutch government has created a very complex regulatory regime. ERES's proficiency operates within this framework and exercises multiple levers to drive robust rent growth as shown on Slide #14. Our strategy is comprised of: one, indexation; two, turnover; and three, the conversion of regulated units to liberalize, which all work together to consistently drive rent growth to the upper end of our original target range of 3% to 4% or in excess of that as we have lately been realizing. Our unique portfolio diversification supports our rent strategy as displayed on Slide #15. We with 2/3 of our portfolio being nonregulated and about half of our property value located in the high-growth ramped-out region, we have a lot of mark-to-market opportunity upon turnover. In addition, 1/3 of the portfolio is comprised of single-family homes, a segment that is even further protected from inflation as tenants perform the majority of the R&M work themselves, which results in higher margins. Further to this diversification, the majority of our units are individually titled. The last piece is important as it provides an additional opportunity to surface embedded value, and that is through the privatization of individual suites. With the primary focus on single-family homes and units in partially owned buildings, we have the option to pull in equity and pay down debt. This provides invaluable downside protection. Our trifold rent strategy is therefore joined by this fourth pillar of unit-by-unit privatization. This comes together to form our broader value maximization strategy in which we're evaluating the net present value of reletting versus privatizing for every suite meeting our qualification criteria. We will not only perform this on churn over but for occupied units, allowing us to tap into both the vacant possession market as well as the existing tenant market. As I've stated before, our fundamental mission remains the maximization of value for all ERES's Unitholders. As you can see that we may have many ways to achieve this in the future. This brings me to our final Slide #17. Moving forward, we will continue to actively explore all additional possibilities for value maximization. At the same time, we remain focused on furthering our established record for robust operational growth and that's supported by the strong market fundamentals we continue to see in the Netherlands. On that 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] Your first question comes from the line of Jonathan Kelcher. Jonathan, your line is open.
Thanks. Good morning Just on the last thing you talked about there, Mark, in selling individual assets. I don't think you sold any in the quarter. Is that something that's on hold as you guys work through the strategic review?
It's not on hold. I'm pleased to report we sold 1 unit since we started the process, but the program has literally just been activated in the last couple of weeks. Perhaps Karim could give some color on that one unit?
Yes. Thanks, Mark. So we took the second quarter to really come up with a strategy. So we build a decision 3 in order to select the units that would be preferable to sell. So we came up with a list of around 2,000 units that on turnover, if you listed on that list, we put it for ourselves. So we've only done one cell in the last quarter. We're completing an sales we're talking we have about 20 units under review for sale. And the decision 3 is basically looking at the CapEx techniques, the rent lift that goes into it, what kind of mortgage is on it. and different cultures. The idea is to sell our best assets to keep portfolio value, but really getting great value on those assets that are less desirable on the rental side.
Yes. So to be clear, we've identified the university possibility, but the volume, we don't expect to be very much at all. It's really on turnover, we're focusing now. And as I said in the slide deck and cribs alluded to, we're looking at the highest and best use either revenue or sale. So I don't expect this to be a highly active program at this point, but we're definitely getting educated and we're very happy with the results we've seen, not just in the 1 unit that's closed, but some of the others that are going to be announced.
Your next question comes from the line of Himanshu Gupta. Your line is open.
Thank you and good morning, guys. So regarding the mortgage financing done this quarter, did you get the appraisal done for the refinancing? And how did the value compare to your IFRS or the last time the you did the appraisal on those?
Sorry if you mentioned I missed the first part.
So Jenny, my question is, did you get the appraisal done for the mortgage financing? And how do the values come up in the phases compared to IFRS or compared to the last time you had done appraisal on those properties?
So our lenders do require us to get independent appraisals done for it as compared to what we do on a qual basis, the valuations were pretty similar, but obviously compared to when we first got the mortgage 5, 6 years ago, get appreciated.
Yes. The other thing to -- Himanshu, that I think we talked about on the last call that continues to be issue is there are so few trades in the Netherlands. Now valuations are using a certain methodology, and I wouldn't read too- too much into things. There's a pause right now. We've been conservative in our overall valuation. But we expect to see some pickup in the marketplace in terms of trading activity, which will give us a better sense of NAV.
Got it. And what was the loan to value by the lenders? Has that come down from like last couple of years?
It is a little lower than what we've achieved in the past. The banks are definitely more conservative in this environment, not to say we couldn't get a higher leverage but it would come at a price.
Okay. Okay, thank you. And then, Mark, on the privatization of individual units, is there any large player in the market which has successfully done a privatization and any sense how long will it take to, let's say, if you were to dispose of 2,000 units, how many years or months will it take to do -- to execute something like that?
So the interesting thing about the Netherlands is virtually all owners of apartment buildings have a privatization strategy, ERES had entered the market with a different view of holding income. But it's very, very normal in the market for owners of rental property to have privatization strategy. Our strategy for now is really a learning mode, and we're being exceptionally cautious about exceeding IFRS value and mitigating, as Karim talked about some capital exposure. So a variety of ways of looking at things. But the expectation from the market should not be material in terms of the trading of units. I would expect this year, I would be surprised to see us get to 100, but that's completely speculative. We'll update the market more as we go. But right now, it's a learning exercise. And it's something that others are doing and really embedding the process with the team and how we run things is really the most important part as we go forward.
Got it. Thank you. Very helpful. Yes, sorry, go ahead, Mark.
No, it's just proving out how conservative our NAV is like as we do these, we're seeing quite a spread of difference between the NAV value and what we're selling for easily 10% to 30% more on the ones we've evaluated today.
Got it. Thank you. Thank you, Mark, and I'll turn it back.
Your next question comes from the line of Mark Rothschild. Mark, your line is opened.
Hey, thanks guys, it's Mark. Mark, just to follow up on the discussion about the sale of assets. Is your preference to do this gradually over time or maybe to do something larger, quicker? And does the Board have maybe a different view? Or what's the Board's view on how this process should evolve because obviously, selling the homes is going to take a long time and considering where the unit price is, what is the thought on the ideal timing of doing something?
The board is very supportive of the strategy. What we want to be mindful of is the learning here is IFRS valuations are just IFRS valuation. So we want to optimize the right units. And again, I'm getting into the weeds a little bit. We'll be doing a deeper dive in our Investor Day coming up on how our methodology works. But each and every year, we're looking at the income value and we're looking at the resale value, freehold, and we're looking at things like capital exposure, and we're also looking at optimizing the portfolio's location and really digging into trying to dig up quite dramatic differences from stated NAV and resale value. And so we're going to be cautious as we do it. But I would expect that as we get better at this and as our team is able to flow through the paperwork better, and mail it in a responsible way, you'll see an acceleration of the program. But it's a great, great way to pay down some debt. It's energizing the team locally and it's a real prove out of what the actual valuation of this portfolio is. So there's a number of factors other than just cash here that are really strengthening and exciting the organization.
So just to follow up on this since I understand. Are you saying that do you view this as an ideal way to surface the value? Or is it just that this is the best way or the only way available right now?
No, this is one of the -- like I continuously said, my only mission in my role here at ERES to surface value through any possible measure. And this is typical activity in the Netherlands is privatizing units. If you're an owner of a rental portfolio, you've got a privatization strategy, and that's something that's been missing from our story. So we're evolving that now. And it's just part of our responsibility to surface value. So in a responsible way. And again, right now, we're moving quite slow on turnover units, but there's nothing preventing us from offering mines to sales to our existing residents, which I think would go over quite well in the Netherlands. People are -- there's a housing crisis there. They want the ability to buy their homes. And it's a traditional practice in the Netherlands for rental portfolio owners to offer homes to the residents at premium values.
Understood. Okay. Thanks, it's very helpful. Appreciate it.
Your next question comes from the line of Matt Kornack. Matt, your line is open.
Hi, Guys. It's probably only 14 units or so, but I noticed that the rent change on regulated suite turnover increased to 13%. Is there anything to that? Or was it specific to the units that were turning?
Yes, Matt, sorry, specific to the units. We did get sometimes just units at much higher points and it still remaining regulated. The rental was extremely low. And as we have year-to-year only 4% turnover in all are regulated, you just need a couple to see the number. But we've seen a tendency for that percentage to go up. This is quite high this quarter, but there's a tendency going up.
Okay. No, that makes sense. And it's a really tight market. And then on the current taxes, what is a good kind of quarterly figure understanding that it fluctuates with your income? But is the current quarter a bit higher than it should be or where should that be on a kind of quarterly basis?
No, it's a good run rate where we are.
Okay, that's it. Thanks.
Thanks, Matt.
Your next question comes from the line of Jimmy Chen. Jimmy, your line is open.
Thank you, guys. Just one question for me. In terms of the strategic review, what would be your expectation in terms of timing when you'd be able to be in a position to tell us sort of the outcome of that review?
Well, reviews 2 thought through carefully and we're in not a great rush here. The time line is just not something that we're talking a bit right now, but we're progressing. And again, my role is to surface value for any measure possible, and we'll do that.
Okay, thank you.
Thanks, Jimmy.
Your next question comes from the line of Dean Wilkinson. Dean, your line is unmuted.
Thanks. Good morning, everyone. Mark, just a question on the mechanics of the mortgages there. So when you carve out an individual unit, do you have to go for a mortgage amendment? Or is there something that's included in sort of a Dutch mortgage that allows for this? Or just how does that work?
It's a various to question because there are mortgages that allow privatization to happen, and we have some mortgages that do not allow privatization to happen. So it does vary. Jenny, you can curve a little bit more detail on that?
Yes. So it's really on a mortgage-by-mortgage basis of what we currently have. There are certain mortgages where we don't have to pay that anything, give us our leverage is above a certain point. There's other ones where when we repay, we had to pay like anywhere between 120% and 150% of the allocated loan amount back. And then there's other ones where as long as we do less than x million of sales a year that we don't have to repay. So it really differs.
Got it. So I'm assuming in the 2,000 or so that you've identified, those would likely be the ones that have a less onerous sort of mortgage book in them.
Exactly.
Yes. And that's why the universe is for now is quite small. We could get more aggressive with it as the mortgage is obviously renewed, that opens up the opportunity to relook at terms when we enter into a new mortgage. But again, right now the primary use of capital for some of these sales is paying down the revolver in the mortgage pools that we have the ability to do privatization.
Right. And none of those assets are cross collateralized, I assume.
No.
Perfect. That's it for me. Thanks.
Your next question comes from the line of David Chrystal. Dave, your line is open.
Thanks. Good morning, guys. Obviously, the transaction market is incredibly slow. I don't know if anything has transacted recently last quarter. You mentioned, I think, maybe one transaction in the country. Have you guys shopped any wholesale assets and any buildings rather than just the individual asset dispositions?
No.
Is that something you…
At the end of the day, there's not a lot on the market to be perfectly blunt. A lot of -- and this, again, speaks to value. A lot of owners aren't prepared to take their assets to market right now. So -- but there's a housing crisis in the Netherlands, and there's an incredible market for home purchasing. Prices have fallen off a little bit, just like Canada, but still the disconnect between lab and the home sale market is still substantial.
And then maybe along the line of question of the individual unit sales, and you've mentioned that the existing players are -- it's part of their strategy. Is there any opportunity to maybe sell a building and let them deal with the headache of individual asset sales? Or do you have a sense of once you get streamlined how quickly you can sell these assets?
Yes, we could. But the intention here is to get good at this, and it's not as complicated as you think, like the headache is not an excuse to make money. If we can maximize and surface value ourselves, then we have that responsibility to our unitholders. Like they're already titled. In Canada, what happens quite often have an ask if you want to sell it to somebody that wants to get a title and go through that has then yes, that's not a core business. This is pretty straightforward, though.
Okay, thanks. I'll turn it back.
There are no further questions at this time. I'd like to turn the call back over to Mark Kenny for closing 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 any of us here at ERES. Thank you again, and have a great day.
This concludes today's conference call. You may now disconnect.