Morguard North American Residential Real Estate Investment Trust

TSX:MRG.UN

Earnings Call Transcript

[Operator]

Good afternoon. My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Morguard North American Residential Real Estate Investment Trust First Quarter Results Conference Call. [Operator Instructions] Paul Miatello, you may begin your conference.

[Paul Miatello, Vice President]

Thank you very much. And welcome, everybody, and thank you for joining us at our Q1 conference call for Morguard North American Residential REIT. I'd like to inform you that Rai Sahi is not available today, he sends his regrets. And I'd like to also introduce the management or the senior management team that's on the call here today with me. I have Bob Wright, Chief Financial Officer; Sanjay Ratejay, Vice President, Operations, responsible for Canada; and John Talano, Vice President, Operations, with responsibility for the U.S. As is customary, I will turn the call over right now to Bob Wright, who will read some prepared comments, and then we'll open up the floor for questions. So with that, over to you, Bob.

[Robert D. Wright, Chief Financial Officer]

Thank you, Paul. As is customary, I will provide comments on the REIT's financial position and performance, then we will open up the call for questions. In terms of our financial positions, the REIT completed the first quarter of 2018 with assets totaling $2.8 billion compared to $2.7 billion in December of 2017. The increase in assets during the 2018 was due to a fair value gain of $71 million and a change in foreign exchange rates during the quarter, representing an uplift in asset value approximately $42 million. The REIT finished the first quarter of 2018 with $18 million of cash and $4 million owing to Morguard Corporation under the revolving credit facility. The REIT has a $100 million credit facility, which can be drawn in either Canadian or U.S. dollars, which the REIT can use for acquisitions and general purposes. The REIT completed the first quarter of 2018 with $1.2 billion of long-term debt obligations. There was no refinancing activity in the quarter, however, early this week, the REIT continued to make progress in strengthening its balance sheet through financing activities, with refinancing of 2 residential properties in the amount of USD 62 million at a weighted average interest rate of 4.07%, about 60 basis points lower than that in place in the interest rate, with the weighted average term of -- as at March 30 -- as at March 28, sorry, I apologize, the REIT overall weighted average term to maturity was 6 years, with 6.2 at December 31,2017. The REIT's weighted average interest rate was slightly increased to 3.5% from 3.0% at December 31. The REIT continues to make progress in reducing its overall leverage. The REIT's debt-to-gross book value improved from 51% at December 31 to 50% at March 31, 2018. MRG has an IFRS net asset value of $22.36 per unit as of March 31, 2018, compared to book value of $14, still reflecting a significant discount to the current trading price. Net income increased by $77.9 million to $80.4 million as compared to 2017. The increase was primarily due to higher noncash change in fair value, the increased property and the fair value of Class B units compared to 2017, partially offset by an increase in deferred tax compared to 2017. Proportionate share NOI increased from $1.5 million or 5.1% to $30.2 million compared to $28 million in 2017. Interest income -- interest expense increased by $0.05 million compared to 2017. Excluding noncash fair value adjustments, interest expense decreased by $1.3 million. The REIT's 2018 performance has been translated into basic FFO of $14.7 million, generated for the 3 months ended March 31, 2018, a decrease of $0.5 million or 3.5% compared to 2017. On a per unit basis, FFO up to $0.29 per unit for the 3 months ended March 31, 2018, a decrease in $0.01 to 3.3% compared to $0.30 per unit in 2017, resulting from the change in foreign exchange rates. The REIT's FFO payout ratio for the 3 months ended March 31, 2018 was 17.0%. Operationally, the REIT has had successful quarter, with average monthly rents in Canada increasing to $1,336. This reflects the quality of the Canadian portfolio and translates into an overall 2.8% increase in rent levels over 2017. While in the average -- while in the U.S., average monthly rents increased 17%, having an average monthly rent of USD 1,211 at the end of the first quarter of 2018 compared to $1,033 at the end of Q1 2017. U.S. same-property average monthly rents increased 3.1%. The REIT experienced strong rental growth in all U.S. markets, except Louisiana and North Carolina. The REIT continues to be strong -- to report strong occupancy, with Canada finishing in the first quarter of 2018 at 99.2% compared to 98% a year ago. Same-property occupancy in the U.S. decreased to 92.7% from 93.8% in 2017. The increase is due mainly to current economic conditions in oil-driven markets such as Louisiana; increased demand of single-family homes impacting certain properties in Atlanta and Georgia; and an increase in new supply currently in lease-up with the REIT's properties in new lease submarkets, including Dallas, Atlanta and Colorado. However, subsequently, same-property occupancy in the U.S. has improved from the 91.4% occupancy reported in December of 2017. The REIT's occupancy within Colorado, Texas and North Carolina improved sharply compared to the December 31, 2017, resulting in increased market efforts and beginning of the spring leasing season, while maintaining MRI growth that satisfies tenants within each respective submarket.Occupancy levels at the U.S. properties acquired by the REIT during 2017 have also been impacted by new supply and leasing seasonality, particularly in Chicago and Maryland. Management has seen recent improvement and expects these impacts to be short term in nature as the competitive properties complete the initial lease-up. Coast at Lakeshore East and Northgate at Falls Church improved occupancy since the fourth quarter of 2017. And although Fenestra decreased in occupancy, all 3 have [ been ] significant improvements in traffic and leasing activity going into the spring, which will represent a key leasing season for these properties. We expect current occupancy levels to continue to improve as the new product stabilizes and management continues to focus on monitoring MRI growth. I will now turn the call back to the moderator, who will open the line up for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Fred Blondeau of Echelon Wealth Partners.

[Frederic Blondeau, MD & Head of Real Estate Research]

I have 2 quick questions for you. The first one is, last quarter, I remember you mentioned you had transitional issues, notably in Chicago, and I was wondering if you had any update for us on this matter.

[Robert D. Wright, Chief Financial Officer]

John, do you want to take it?

[John Talano, Vice President of Operations]

Sure, sure, sure. Hey, this is John Talano talking. Actually, yes. We -- When we actually took over that -- both the properties, Chicago and in Washington, D.C., we essentially locked the entire management staff. So we went through a hiring process and trying to get the right team in place. Chicago, we are actually 98% leased today at Coast, so we're really excited about that and made huge improvements. So that property is now doing very well. It's actually 90 -- it's 94.7% occupied as of today, so that one is great. And the same was the case really for Washington, D.C. because when we took over the properties, we had the same staffing issues where the previous management team literally took all of the employees. So that quickly brought us into November, into the winter months, and we really ended up sitting on a lot of that vacancy over that period. But just in the last 2 weeks, our traffic has doubled, both at Northgate and Fenestra. So both of those properties are pushing right now at about 90%, 92% leased. Northgate is a little ahead in occupancy, but Fenestra is catching up, so we feel like we're going to make some great progress over the next several weeks there as well.

[Frederic Blondeau, MD & Head of Real Estate Research]

So I guess you have no longer operational issues, per se?

[John Talano, Vice President of Operations]

Correct. But we have -- yes, we have stabilized both the Chicago portfolio and D.C., and we're fully staffed at all those properties.

[Frederic Blondeau, MD & Head of Real Estate Research]

Okay, perfect. And my second question. You guys once again mentioned that new supply is an issue, notably in Dallas, Atlanta and Colorado. And I was wondering, what's your outlook on this aspect? And if you could expand a little bit on your views on new supply in your markets right now.

[John Talano, Vice President of Operations]

Sure. In Colorado, the supply issue was specifically in Fort Collins. There was 1 new property, and it's a smaller market, so it had a significant effect on us over the winter months. That property did lease-up as well, and we're in good shape there. I believe we're up in Colorado, actually, 8 points over last quarter in terms of occupancy. The same is the case in Texas. There was a 3% increase in occupancy there as well. So those markets are in great shape. The one that we're watching the most now is only 1 of our 3 assets in Atlanta, and it was really just a new property within a few blocks of us that had a significant effect. So that property itself is well on its way in terms of its lease-up. So that one, we're seeing improvement as well. The other 2 Atlanta properties are right where we want them to be, one's 97% occupied today, and the other is right at 93% but climbing quickly.

[Frederic Blondeau, MD & Head of Real Estate Research]

So should we expect same-store occupancy to improve next quarter or...

[John Talano, Vice President of Operations]

Yes. I would say, based on our leasing momentum today, it will, absolutely.

[Operator]

Your next question comes from the line of Dean Wilkinson of CIBC World Markets.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Just a question on the cap rates. You cited 25 basis points compression in several of those U.S. markets. Was that a result of transactions you saw in those markets? Or was it more related to the increase in the assessed values from the tax perspective?

[Robert D. Wright, Chief Financial Officer]

The cap rate changed, Dean. There's a little bit of the former, few transactions that we've observed in the marketplace. The other thing is that, no surprise, but like, one of the major inputs into the appraisal process is looking at cap rate surveys. And so we've seen some common compression in a few of the different surveys that the appraisers use, so you start seeing that trend. A lot of judgment involved, obviously, but some of these surveys you've seen a little bit of compression over 1 or 2, through maybe 3 quarters. Some of them, literally, see it pop up a little more recent. But you'd see a little more cap rate compression in the surveys bubbling into all -- most of the surveys, and so you just start to form conclusions based on that but also based on a couple of transactions that have taken place.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

And in terms of increased value on the assessments, were they effectively looking at the same thing as well? Or...

[Robert D. Wright, Chief Financial Officer]

Sorry, when you say assessments, are you...

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Property tax assessments.

[Robert D. Wright, Chief Financial Officer]

Property tax assessments. Yes, I'll -- Yes, I mean, generally, we're seeing property tax assessments increase, but maybe I'll ask John to add a little more color. Maybe specifically in Florida, John because I know, like, that's where we kind of had the biggest impact from the cap rate bump.

[John Talano, Vice President of Operations]

Right. And I would say it's 2 things [ bulging ] on it. First, it -- there were a few transactions in our smaller markets, Pensacola, that I think gave some clarity on cap rates, and those rates were a little bit lower than previous quarters. But the Florida assessors are absolutely lowering their cap rates through our assessments and especially with our recent transactions or our properties that we've purchased there. They're simply marking them to market. The number actually is 85% of sale value and there have been many -- especially in South Florida, there's been many recent transactions where you can see that significant cap rate compression.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Right, makes sense. And then the other question for me, I guess it's probably for John. On the sort of the subsequent asset purchased in New Orleans, I guess there's really not a cap rate as you expect the vacancy to be 100%. But how much are you looking to spend sort of in that capital upgrade? And then what would be sort of the cash-on-cash yield for the entire thing once you're done?

[John Talano, Vice President of Operations]

Well, it is just under $2 rents for that property. The acquisition cost was right under $100,000 a door, and the capital plan is right around $5 million. So right, so that's 116 units.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

And then where do you think the rents would go to from then?

[John Talano, Vice President of Operations]

Oh, from the renovations?

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Yes.

[John Talano, Vice President of Operations]

Yes. So we're projecting 3% growth there. The property should be operating well over a 7 cap at that point.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Okay, 7. That makes sense to buy it that way then, for sure.

[John Talano, Vice President of Operations]

Well -- And it was a strategic acquisition with a relationship with -- that we had with Tulane University. They actually purchased that back in 2005 actually, right after Katrina, for student and faculty housing. And they did not operate as an apartment community. It's actually -- was built originally as a condominium. So it's -- it was performing significantly under where it should be, so there's a significant -- it's a small property, it's only [ 116 ] units, but there's upside there, for sure.

[Operator]

[Operator Instructions] Our next question comes from the line of Jonathan Kelcher of TD Securities.

[Jonathan Kelcher, Analyst]

Just continuing on a -- do you guys see much in the way of more opportunities in terms of buying assets that you have to rework a little bit?

[Robert D. Wright, Chief Financial Officer]

We -- I mean, probably the quick answer is no. I mean, this acquisition we did subsequent to the quarter was a little bit unusual for us. I mean, like, we're typically a little more buyers of core assets. This is a little unusual for us, and I think it was also immaterial. But this property is about 1.5 blocks away from one that the REIT already owns, called The Georgian. So obviously, once it's completed, and we're going to lease-up, there'll be some management synergies and efficiencies from that. If this was a standalone acquisition, we probably wouldn't have done it, John. So I mean, again, it's not typically -- I mean, we'll buy something and I mean, do the light retrofit. This year, based on the budget John was talking about, we're talking over $40,000 a unit average that we're putting into this. So this isn't the typical thing that we would do.

[Jonathan Kelcher, Analyst]

Okay. And will it be targeting students or faculty or...

[John Talano, Vice President of Operations]

We actually have several grad students and faculty of Tulane at The Georgian. And in fact, there were several that recently moved into The Georgian prior to the acquisition of this -- from this building. So we will have a good mix there, but we're going to be targeting young professionals. These are larger units, so The Georgian on average is right around, I believe, it's 750 square feet. There's 69 studios there that are about 500 square feet, and these are much larger units, over 1,000 square feet per unit. So 9-foot ceilings, washer and dryers in the unit, it will be a nice package.

[Jonathan Kelcher, Analyst]

Okay, and you'll be looking for sort of $2,000 average rent, like at 1,000 square feet?

[John Talano, Vice President of Operations]

Right.

[Jonathan Kelcher, Analyst]

Okay, turning to the Ontario portfolio, what sort of lifts are you guys getting on turnover right now?

[Sanjay Ratejay, Vice President of Operations]

Yes. We're getting close to $1, $1.50. It totally depends on which market the buildings are, but we're trying to push it up as much as we can in the different markets.

[Jonathan Kelcher, Analyst]

Sorry, $1, $1.50, is that...

[Robert D. Wright, Chief Financial Officer]

How much [ lift ] are we getting?

[Sanjay Ratejay, Vice President of Operations]

[ Lift in ] percentage?

[Robert D. Wright, Chief Financial Officer]

Yes.

[Sanjay Ratejay, Vice President of Operations]

Yes, so it will be close to -- I was going to say -- Okay, 1% on the rent to 1.5%, 2.46% is the rent that we were achieving. And so I would say around 2%, 2.46% as far as the average monthly rent is concerned.

[Jonathan Kelcher, Analyst]

Great. Now is that on turnover on empty units where you can charge that...

[Sanjay Ratejay, Vice President of Operations]

Yes, on turnover, on turnover units, yes.

[Jonathan Kelcher, Analyst]

Okay, and have you noticed any change in the level of turnover the last couple of years?

[Sanjay Ratejay, Vice President of Operations]

It's definitely decreased. It's -- The turnover is lower than other years. That's what we are experiencing.

[Operator]

There are no further questions at this time. I will turn the call back over to the presenters.

[Paul Miatello, Vice President]

Thanks very much, everybody, for joining us, and we'll speak to you again at the Q2 conference call. Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.