Morguard North American Residential Real Estate Investment Trust

TSX:MRG.UN

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Morguard North American Residential REIT First Quarter Conference Call. At this time, all lines are in a listen-only-mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]. This call is being recorded on Thursday, April 27, 2023.

I would now like to turn the conference over to Paul Miatello. Please go ahead, sir.

[Paul Miatello, Senior Vice President]

Hi. Thank you very much and good afternoon everybody and thank you for joining us for the REIT's first quarter conference call. I'll just do a quick roll call for everybody. So with us, we have Chris Newman, Chief Financial Officer; Rai Sahi, Chairman and Chief Executive Officer; Angela Sahi, Senior Vice President, Canadian Operations; John Talano, Senior Vice President of U.S. Operations; and Beverley Flynn, Senior Vice President and General Counsel.

So I will now turn the call over to our Chief Financial Officer, Chris Newman, to give us an overview of what was a very strong quarter results slides for the release. So we're happy to present on this, and then we'll turn it over to the operator for questions and answers. Chris?

[Chris Newman, Chief Financial Officer]

Great. Thank you, Paul. As is customary, I'll provide comments on the REIT's financial position and performance.

In terms of our financial position, the REIT completed the first quarter of 2023 with total assets amounting to $4.1 billion, higher compared to $3.9 billion as of December 31, 2022. This is a result of a fair value increase in the REIT income producing properties of $67 million and the acquisitions completed during the quarter.

During the first quarter, the REIT completed the following transactions. On January 5, the REIT acquired for Morguard Corporation, the remaining 50% interest in Fenestra at Rockville Town Square, comprising 492 residential suites for a purchase price of U.S.$71.5 million, including closing costs and the REIT assumed mortgages payable of U.S.$34 million. The REIT now owns 100% of this asset.

And on March 29, 2023, the REIT acquired Xavier Apartment, a multi-treat residential property comprising 240 suites located in Chicago, Illinois for a purchase price of U.S.$84 million, including closing costs. The acquisition was funded primarily from sales proceeds from the disposition of a property during the fourth quarter of last year as the REIT utilized the tax deferred strategy under Internal Revenue Code Section 1031, where the REIT was able to defer tax payable upon the acquisition of the Xavier apartments.

The REIT finished the first quarter with 24.2 million of cash on hand and 49.3 million drawn on the REIT's $100 million revolving credit facility with Morguard Corporation with approximately $50.7 million available remaining under the facility. As well the REIT issued $56 million of 6% convertible unsecured subordinated debentures and fully repaid $85.5 million of its maturing 4.5% convertible unsecured subordinated debentures.

The REIT completed the first quarter with $1.3 billion of long-term debt obligations. As at March 31, 2023, the REIT's overall weighted average term to maturity was 4.7 years, a decrease from 4.9 years at December 31, 2022, and the weighted average interest rate increased from 3.52% from 3.5% at December 31, 2022.

The REIT's debt to gross book value ratio increased to 38.9% at March 31, 2023, an increase compared to 38% since December 31, 2022. Subsequent to quarter end, the REIT entered into a binding agreement for the CMHC financing of residential property in Toronto, Ontario in the amount of $61.1 million at an interest rate of 4.18% and for a term of 10 years. And the REIT also entered into a binding agreement for the refinancing of two U.S. residential properties for an aggregate amount of U.S.$61.1 million at an interest rate of 5.06% and for terms of 10 years. And we'd expect the refinancing to close at their scheduled maturity date on day 1, 2023.

Net income was $34.2 million for the first quarter compared to $171 million in 2022, the $136.9 million decrease in net income was primarily due to the following non-cash items, a lower fair value gain on real estate properties of $180 million relative to the gain recorded during 2022 and was partially offset by a lower fair value loss on Class B LP Units of $12 million and a decrease in deferred income taxes of $29.2 million.

IFRS net operating income was $19.3 million for the first quarter of 2023, an increase of $1.9 million or 10.8% compared to 2022. Change in foreign exchange rate increased NOI by $0.4 million of the overall variance to last year. And on a same-property proportionate basis, NOI in the U.S. increased by U.S.$1.7 million or 10.1%, as an increase in revenue from AMR growth and in ancillary income was partly offset by higher vacancy and an increase in operating expenses. NOI in Canada increased by $1.6 million or 12.8%, mainly due to AMR growth and lower vacancy, partly offset by an increase in operating expenses. And the change in foreign exchange increased same-property proportion NOI by $2 million.

Interest expense increased by $0.4 million for the first quarter of 2023 compared to 2022, primarily due to an increase in interest on mortgages of $2.3 million, mainly resulting from higher principal and interest rates on the completion of the REIT's refinancing during 2022 and the net impact of acquisitions and dispositions, which were partially offset by a higher non-cash fair value gain on the convertible debentures conversion option.

The REIT's first quarter performance translated into basic FFO of $22 million, an increase of $3.6 million or 19.9% when compared to 2022. And on a per unit basis, FFO was $0.39 per unit for the three months ended March 31, 2023, an increase of $0.06 compared to $0.33 per unit in 2022. The increase in FFO per unit was due to the following on a same-property proportionate basis and in local currency, an increase in NOI from higher AMR and lower vacancies, was partly offset by higher operating expenses, an increase in interest expense and an increase in trust expenses at an overall $0.03 per unit positive impact. And in addition, the change in foreign exchange rate had a $0.02 per unit positive impact.

Also, the impact from acquisitions and dispositions were offset having a nil impact and an increase in other income, primarily from interest income earned on restricted cash held as part of a 1031 exchange from the disposition proceeds last year had a $0.01 per unit positive impact. The REIT's FFO payout ratio continued to decline to 46.1% for the 3 months ended March 31, 2023, a very conservative level, which allows for significant cash retention.

Operationally, the REIT's average monthly rent in Canada increased to $1,613 at March 31, 2023, a 3.7% increase compared to 2022, reflecting the quality of our Canadian portfolio.

During the first quarter, the Canadian portfolio turned over 2.4% of total suites and achieved AMR growth on suite turnover of 22.5%. While in the U.S., same-property AMR increased by 11.3% compared to 2022, having an average monthly rent of U.S.$1,760 at the end of March 2023. As the REIT continued to its strong performance, benefiting from strong market fundamentals across many regions.

The REIT's occupancy in Canada finished the first quarter of 2023 at 98.6% compared to 93.8% at March 31, 2022. Rental market conditions remain stable as housing demand continues to outdistance supply. Same-property occupancy in the U.S. of 95% at March 31, 2023, was lower compared to 96.3% at March 31, 2022. [Indiscernible] expect leasing activity to maintain stable occupancy levels as we move into the busy spring leasing season. And during the 3 months ended March 31, 2023, the REIT's total CapEx amounted to $5 million that included revenue-enhancing in suite improvements, common area, mechanical, plumbing and electrical as well as exterior building projects as we continue to ensure we maintain the structural and overall safety of our properties.

At this time, I'll turn the call back over to the moderator to answer any questions.

[Operator]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. Your first question comes from the line of Jonathan Kelcher from TD Cowen. Please go ahead.

[Jonathan Kelcher, TD Cowen]

Thanks. Good afternoon. First question, just on the U.S. leasing, we have been reading a lot about market rent stalling, maybe even falling a little bit, and I think was attributed to seasonality. But now you're entering the spring season, how do you expect that to play out?

[Paul Miatello, Senior Vice President]

John, do you mind answering that question?

[John Talano, SVP, U.S. Operations]

Sure. Sure, not at all. Actually, things are pretty good. We're 95% occupied today overall and actually 97.8% leased. So we are in a very good place going into spring. I think a lot of what we were seeing was more seasonality in the northern regions, Chicago, D.C., those markets. And that is very seasonal, right? Very few folks move in the winter months, but we are expecting good results and our trends are good, too. So looking 60 days out. We're not having a significant number of move-outs. So the markets seem good. And it's still early, right? It's still early for markets like Chicago and D.C. But starting next month, May and June will be very busy. And there isn't a whole lot of supply as well, new supply that's come out. So those markets, too, I think, will do fairly well.

[Jonathan Kelcher, TD Cowen]

What would you think your current mark-to-market is?

[John Talano, SVP, U.S. Operations]

We still have some room. Our rents, we did raise them, obviously, over the last year or two very aggressively. The taste has slowed definitely, especially in the winter months. But we still have room from our folks that are living with us below market. Those rents are still below where asking will be today. It depends, obviously, on all the various markets. But we were very cognizant about that, maintaining our occupancy as things were increasing. So that's left us a little bit of runway between what folks are paying with us on renewal and what market is today.

[Jonathan Kelcher, TD Cowen]

Okay. And then, if you look at your markets right now, and I guess this goes for the whole portfolio in U.S. and Canada, are there any markets or assets where you'd be looking to exit?

[Paul Miatello, Senior Vice President]

Maybe John, is there any comments from the U.S. side. I highly got anything from the Canadian side will happen. But John, if we continue to look for assets to improve on every year.

[John Talano, SVP, U.S. Operations]

Yes. No. I would say our existing portfolio is relatively core. We capitalized on some older assets when the timing was really good. And I think we did really well with what we're able to dispose of and acquire. But there aren't any residential assets on the radar is something that we would consider trading today.

[Jonathan Kelcher, TD Cowen]

Okay. Thanks for that. I'll turn it back.

[Operator]

Thank you. [Operator Instructions]. And your next question comes from the line of Khing Shan from RBC Capital. Please go ahead.

[Khing Shan, RBC Capital]

Thanks. So obviously, Chicago is a big market for you now. I was just wondering if you could talk about the outlook for that market in terms of growth profile, especially relative to other markets? What is it that you see in that market that maybe other aren't seeing?

[Paul Miatello, Senior Vice President]

Go ahead, John, if you can. Yes, go ahead please. Yes, please, thank you.

[John Talano, SVP, U.S. Operations]

Sure. I would say that Chicago has been a very good market for us. It is absolutely one of the biggest cities in the U.S. and one of the largest Fortune 500 companies or cities with Fortune 500 companies outside of New York, I think it's number two in the U.S. So there's huge activity. There is a lot of growth. For us, the risks that our competitors have seen was really related to property taxes. And we have done very well with our property tax negotiations and that, I think, scared some folks out of the market and created us opportunities to acquire at some pricing that was highly competitive. And that played out really well so far.

Chicago too does have a significant amount of new inventory that's coming available, but we've been dealing with that for 10-plus years in the city, and we've been able to manage through it. And our occupancies and rent growth has been good. So for us, it's a metropolitan big city that has good fundamentals and a large population of folks in that generation in the high-rises, those luxury high-rises that are 25- to 35-year olds that is vibrant and highly active and has worked well for us.

[Khing Shan, RBC Capital]

That's good color. And then I guess if you were to compare the growth profile in land and occupancy and NOI over the next few years, given that dynamic of property taxes and the new supply in the urban core. Is it your view that they will probably perform on par with the rest of the Sunbell market? How do you think about that?

[Chris Newman, Chief Financial Officer]

In my view, the Chicago got a bit of a bad grasp. And just so you're aware, I actually from there, lived the first 30 years in my live there, I lived downtown for over 10 years. And just having that history with the city and knowing those specific markets and the growth, I think we have some insights that some other companies who aren't local don't have. So that's definitely made it a little easier for us to acquire there. But the growth that we're seeing in Chicago is definitely comparative to what we're seeing in our other markets. And lately, I would say since we've acquired Echelon and Xavier, the cap rates are really good, and the performance of those assets have been good as well. Xavier is already 94% leased. We've owned it for a very short period. And Echelon is right at 98% occupied today. So it's doing very well.

[Khing Shan, RBC Capital]

Okay, great. And Xavier, the cap rate on that would have been in the 5s?

[Chris Newman, Chief Financial Officer]

Yes, just sub-5.

[Khing Shan, RBC Capital]

To sub-5, okay. Okay. And then maybe turning to Canada, and this is maybe more for Chris. You noted the utility expenses in the Canadian portfolio is higher on the year-over-year. I would have thought that, that would have come down because natural gas and down so much, I'm just kind of wondered, if you had any color as to why that might not be the case.

[Chris Newman, Chief Financial Officer]

Yes. I can start on that Khing. We got gas prices, I believe it started to rise midway through last year Q1. So relatively big on the gas prices are a lot more expensive this year and consumption relatively stable. But we do also within our utilities, we have a decrease in water consumption because of [indiscernible] retrofit projects we've done. But we're seeing that the gas prices are driving utility expenses. But I think that Q1 was a mild as last quarter, I don't think there was much of a difference when it comes to the weather patterns. I know sometimes that does fluctuate quite a bit in Q1, but --

[Beverley Flynn]

I think the rates were still in last year or Q1 to Q1. So was the gas that actually brought up the utilities for sure. So in terms of hydro, we are sub-metering and we have the past portfolio that we can sub-meter and sub-meter at this point so that we can do that in turnover. And like Chris mentioned for water, we do have some retrofits and some pretty significant savings as soon as we implemented the retrofit towards the end of last quarter. It's about $200,000 or about 25% to 30% savings for each property. And then the LED retrofits as well, they're bringing us some substantial savings to. So we're doing a bunch of these projects on the top side to take on the utilities moving forward. But the rates are something we can't really control.

[Khing Shan, RBC Capital]

Okay. Sorry, I got a couple more. So then maybe on the GTA assets, obviously, turnover rates come down, net spreads have gone up. How is it tracking into April? And would you say it's kind of stabilized at level or is it accelerating? Any color there?

[Beverley Flynn]

In terms of turnover, turnover is lower for sure, just because of what's going on with the housing market and affordability, people are renting and they're staying put because of just the cost once they turn over those units they move out. So there is very low turnover right now and it's trending to be probably right now above the same. I would say this quarter is what we would expect. In terms of rent growth, it's substantial. I mean I can quote you some numbers, and this is all over north of $3 a foot on some of the smaller units were even at 340 a foot on turnover, even [indiscernible] is approaching 290 foot on turnover. It's just a matter of how many units will actually move.

[Khing Shan, RBC Capital]

Okay. To the turnover rent growth going into April, it seems like -- I'm not sure what that means. I mean it's actually gone up a little bit more from the '22 and change that was the average for the quarter.

[Beverley Flynn]

Yes.

[Khing Shan, RBC Capital]

Okay. And then last, just on the unit buyback. You have not been active on the NCIB for quite a long time. So I'm just kind of wondering what's changed here? And how do you think about the pace of the buyback going forward?

[Chris Newman, Chief Financial Officer]

Yes. I mean, nothing's really changed in our view other than we have like as you pointed out to me. We have become active, but it's always an issue of capital allocation, I guess. So we'll continue to just monitor that. And we are using most days, currently, we're just chipping away at our daily maximum.

[Khing Shan, RBC Capital]

Okay. Thank you.

[Operator]

Thank you. There are no further questions at this time. Please continue.

[Chris Newman, Chief Financial Officer]

Okay. Thanks, operator. And thank you, everyone, for joining us for our Q1 conference call. We look forward to speaking to you next quarter. Thank you.

[Operator]

Thank you. This does conclude the conference for today. Thank you for participating. You may now disconnect.