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 Real Estate Investment Trust second quarter results conference call. [Operator Instructions] This call is being recorded on Thursday, August 2, 2018.I would now like to turn the conference over to Paul Miatello. Please go ahead.

[Paul Miatello, Vice President]

Thank you, and good afternoon, everybody. And it's great to have you guys joining the conference call today. I'm Paul Miatello. I'll be moderating the call today. I'm the Vice President at the REIT and the Chief Financial Officer at Morguard Corporation. Mr. Sahi is not available to join the call today. But joining us on the call is Bob Wright, Chief Financial Officer; Sanjay Ratejay, Vice President of Canadian Operations; and John Talano, Vice President of US Operations.So with those brief introductions, I'll turn it over to Bob Wright, who will give us an overview of the Q2 results.

[Brian M. Roberts]

Thank you, Paul. As is customary, I will provide comments from the REIT's financial position and performance. Then we will open the floor to questions. In terms of our financial position, the REIT completed the second quarter of 2018 with assets totaling $2.9 billion compared to $2.7 billion in December. This increase in assets during 2018 was due to the acquisition of property under development of $15 million, a fair value gain of $106 million, and the charge in foreign exchange rates during the year having an uplift in assets value of approximately $77 million. On April 5, 2018, the REIT acquired the property comprising 116 suites located in New Orleans, Louisiana, for the purchase price of USD 11.4 million. The property is vacant and designated as a property under development. The REIT plans to complete significant capital upgrades during the remainder of 2018 at which time initial lease ups will commence.The REIT finished the second quarter of 2018 with $22 million in cash on hand and $4 million owing to Morguard Corp. under its revolving facility. The REIT has $100 million credit facility, which can be drawn on in either Canadian or US dollars, which the REIT can use for acquisitions and general corporate purposes. The REIT completed the second quarter of 2018 with $1.3 billion of long-term debt obligations. During the quarter, the REIT continued to make progress in strengthening its balance sheet through financing activities with the refinancing of two residential properties in the amount of $62 million at the weighted average interest rate of 4.07%, about 60 basis points lower than in place interest rate. The weighted average term of ten years that resulted in USD 9 million of up financing proceeds. At June 2018, the REIT's overall weighted average term to maturity was 6.3 years, an increase from 6.2 at December of 2017. The REIT's weighted average interest rate declined slightly to 3.48% from 3.5% at December 2017. The REIT continues to make progress in reducing its overall leverage. The REIT debt-to-book value improved to 51% in December compared to 49% June. MRG has IFRS asset value of $23.33 per unit at June compared to market value of $15.40, still reflecting a significant discount to trading value. Turning to the statement of income, net income decreased by $41.8 million to $19.7 million for the 3 months ended June 30 compared to 2017. The decrease was primarily due to lower noncash charges to fair value real estate properties and fair value BLP units compared to 2017 offset an increase in deferred tax compared to the prior year.Net operating income of $38.3 million for the 3 months ended June 30, 2018, an increase of $3.2 million or 9% compared to 2017. Proportionate share NOI increased by $1.6 million or 5.3 to $32 million compared to $30.4 million in 2017. Interest expense increased $2.2 million for the 3 months ended June 30, 2018, compared to '17. Excluding noncash fair value adjustments, interest rate -- interest expense decreased by $1.8 million. The REIT's 2018 performance has translated into basic FFO of $15.7 million generated for the 3 months ended June 2018, a decrease of $0.6 million or 3.8% compared to 2017.On a per unit basis, FFO of $0.31 per unit for the 3 months ended June 30, 2018, a decrease of $0.01 or 3.1% compared to the $0.32 per unit in 2017. The REIT's FFO payout ratio for the 3 months ended June 30, 2018, was 53.6%. Operations -- the REIT has been successful quarter with an average monthly rents in Canada increase to $1,345. This reflects the quality of the Canadian portfolio and translates into an overall 3% increase over 2017. While in the US, average monthly rents increased 17.2% with an average monthly rent of USD 1,221 at the end of the second quarter compared to USD 1,042 at the end of the same period 2017. The same property average monthly rents increased 3.2%, the REIT's strong rent growth in the US market in all places but Louisiana. The REIT continues to report strong occupancy with Canada finishing the second quarter of 2018 at 99.2%, [up from] prior year. Same property occupancy in the US has started to see an improvement over last year's occupancy. Same property increased 93.8% from 93.2% in 2017. Same property occupancy in the US has improved from 92.7% occupancy reported at March 2018, resulting from increased marketing efforts at the beginning of the spring season. Occupancy levels at US properties acquired by the REIT during 2017 have been impacted by new supply and leasing seasonality. Occupancy of all three properties acquired in 2017 improved since the first quarter of 2018 and have seen significant improvements in traffic and leasing activities. This trend is expected to continue throughout the leasing season in these properties. Management has seen recent improvements and expects the impact of the short term in nature as the competitive properties complete their lease up.I will now turn it back to the moderator, who will open the lines for questions.

[Operator]

[Operator Instructions] Your first question comes from Jonathan Kelcher of TD.

[Jonathan Kelcher, Analyst]

First question, on the New Orleans development, how much do you expect to invest in that over the balance of this year?

[Paul Miatello, Vice President]

Yes, the total program will probably end up being around $5 million. It could be a little bit lower. Like the scope is set on the building envelope budget, depending on how much we do in suite improvements. It could go lower than $5 million, but it's -- so the answer is $4 million to $5 million, I'd say.

[Jonathan Kelcher, Analyst]

Okay and then when you get it leased up, what sort of return do you expect on the whole thing?

[Paul Miatello, Vice President]

We're expecting about in the range of 8 to 8.5.

[Jonathan Kelcher, Analyst]

8% to 8.5%?

[Paul Miatello, Vice President]

Unlevered.

[Jonathan Kelcher, Analyst]

Unlevered. Yes, okay that's good. I noticed the incentives ticked up this quarter and actually quite a bit year over year. Is there any one market that that's -- where that's happening or is it sort of across the board? Maybe a little bit of color on that.

[Paul Miatello, Vice President]

Maybe I'll turn that question over to John Talano.

[John Talano, Vice President of Operations]

Sure, the incentives specifically were in Chicago at Coast and in the D.C. markets where we had occupancy -- weakness in occupancy earlier or late last year, earlier this year and then also at one property in Atlanta. And those -- that was where the bulk of it was and that was specifically targeted at those three properties where we were experiencing those lower occupancies. And since that time, we have actually ended all of those. We've seen great results in Chicago. Coast is now 98% leased. So we are -- we have fixed that one. Briar Hill in Atlanta was in the low 80s last quarter. It is also 98% leased. So we've had some great progress there. But again that was really going through a lease up this spring at those properties and we have finished with those.

[Jonathan Kelcher, Analyst]

Okay. So we would start to see that tick down next quarter?

[John Talano, Vice President of Operations]

Absolutely.

[Jonathan Kelcher, Analyst]

Okay and then last for me is just on the G&A was $600,000 higher this quarter versus last quarter. Just wondering what a good run rate is going forward?

[Paul Miatello, Vice President]

Yes, it's a little higher. It's largely on timing of expenditures and some consulting bills that came in. So I think the number we were at is 3.6.

[Jonathan Kelcher, Analyst]

So 3.6--?

[Paul Miatello, Vice President]

Yes, and there's a little -- and yes Chris just pointed out to me, there's a little bit of FX fluctuation in there as well, Jon, but sort of around three and a half, 3.5, 3.6 is a normalized--

[Jonathan Kelcher, Analyst]

Is a good run rate?

[Paul Miatello, Vice President]

Yes.

[Operator]

Next question comes from Fred Blondeau of Echelon Wealth Partner.

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

I just have two quick questions here. First, I was wondering if you could give us a sense of your acquisition pipeline at this point. It looks like you're a bit less active this year.

[Paul Miatello, Vice President]

Yes, a little bit less active. We're still looking at a lot of product, similar markets to where we're in, in terms of footprint right now. It's just things are still to us looking pricey, especially in the face of what we think are going to be more interest rate increases in the year. We still think that there's that traditional sort of disconnection between buyer and seller. You know the seller doesn't think prices have moved and the buyers think prices have moved. So, yes, so it's probably fair characteristic or fair to characterize it as it's a little bit slow right now. But we do -- we are looking at a lot, just on a pricing basis cap rate per door basis. We're just -- we're not seeing anything that we're jumping at right now.

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

Okay, so is it fair to say that you don't necessarily have a pipeline at this point?

[Paul Miatello, Vice President]

Like I said, I mean nothing that's under contract. I mean nothing that's anywhere near that close. But like I said, we are still very active in terms of looking and investigating and lots of conversations going but hard, very hard to predict in this kind of market what's going to come to fruition.

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

And just on Jonathan's question on incentives, what do you see in terms of new supply in your markets at this point? Is it fair to say that based on your comments, it seems like it's becoming less of a challenge here?

[Paul Miatello, Vice President]

I mean I'll just start off by saying, you know Chicago is still a bit of a challenge. I mean there's a lot of -- there's still a fair bit of supply, although it's less than what it was at this time last year. And it looks like it's continuing to slow down but it's still an issue. Sort of beyond that comment, John, is there anything else you can add to that?

[John Talano, Vice President of Operations]

We've had strong supply in south Florida, but as you can see from our occupancy and rents there, those have been performing well. So the demand and supply are matching. Everywhere else has been very stable. I would say Dallas is another area that continues to have a consistent supply, but beyond that the only other area that has a significant supply would be in the D.C. and our Maryland markets. But that too has definitely improved over the last quarter as well. So, the other areas of the country, Colorado, Atlanta, that definitely has calmed down as well.

[Operator]

Your next question comes from Yash Sankpal of Laurentian Bank.

[Yashwant Sankpal, Analyst of Real Estate Investment Trust]

Just on your year's occupancy, just looking out where do you think your occupancy rate would be by the end of 2018, like just a rough estimate like based on what you see?

[John Talano, Vice President of Operations]

Yes, I'll handle that one. Well, we've seen very good trends recently. So with our busy spring and summer leasing season, we have -- the portfolio as a whole it has already achieved very close to 95% occupancy. And that really is our sweet spot where we're trying to push rents where we can. So we are there and --

[Yashwant Sankpal, Analyst of Real Estate Investment Trust]

About 95% in the US or are you talking about Canada and US?

[John Talano, Vice President of Operations]

We're approaching 95%. It is very close today. And the goal is to stay around that mark.

[Yashwant Sankpal, Analyst of Real Estate Investment Trust]

Okay, that's good. Also in terms of acquisition cap rates, like what do you see out there, like can you give us some commentary around like where cap rates are and if they're like the expectations are changing or not, like anything?

[Paul Miatello, Vice President]

Yes, I mean we're seeing for the garden-style wood frame, 3-story walk up, sell product, 2 and 3-story walk up, depending on location, depending on construction and finishes, you're seeing cap rates in the low 5s, 5.5 and then up from there. As I said in my earlier comment, that that has tended not to move over the last few quarters. We've seen live -- you know tiny bit of compression here and there in certain markets. But the cap rates have sort of remained stable, you know sort of in the face of interest rate increases that happened over a year ago and that's what I'm sort of alluding to in my earlier comment. The boil has sort of come off. Certainly in US markets, we're seeing a little bit of deceleration of rent growth. You know John talked about that in an earlier comment. A year, year and a half ago we were still seeing rents increases in the US in the 4s, 5s, 6s, 6% range, 7% range year over year in some select markets. And those, those 5, 6, 7s are now 2% to 5%. So the rent growth has definitely decelerated. So you sort of look at that combination of factors again coupled with interest rates and everything and it sort of feels like pricing should be coming off the boil. But like I said it -- expectations between buyer and seller are still different I think which makes it difficult to get deals done.

[Operator]

Your next question comes from Dean Wilkinson with CIBC.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

On the Canadian portfolio, year to date suite turnover, 8.8%, obviously a low number. I'm assuming that is trending lower. How does that number compare to first half of the year going back the last couple of years?

[Paul Miatello, Vice President]

I don't have that in front of me. I'm not sure if we have that number in the room, but it definitely -- I can tell you for sure without quoting a number, it's down.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

It's down.

[Paul Miatello, Vice President]

And then that's just purely a function of -- and again a lot of our understanding that a lot of our Canadian portfolio is located in the greater Toronto area. It's just such a tight rental market. So we're seeing big rent increases on turnover and we're seeing lower turnover, just because there's less options. And it's also a function obviously of the housing industry here in Toronto.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Housing shortage, rent control, all the rest of those things?

[Paul Miatello, Vice President]

Yes, like that whole basket of circumstances just sort of leads you -- leads one to understand that easily that there's just less turnover. People have less affordable options to look at, you know whether they want to rent a condo or buy a condo or buy a house or buy a townhome. The options, the affordability of the options just aren't great. So, we're just finding that people are sticking around longer, which isn't necessarily a bad thing, but again in the Canadian landscape on turnover when we can get --

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Yes, it's a big gap.

[Paul Miatello, Vice President]

8% to 10%, you kind of -- you're hoping for that turnover. So, yes, it's definitely down just for those reasons, Dean.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Would there be a little more of seasonality say in the back half of the year that turnover picks up a bit? Like, or would you think that high single digits might be the world that we're in?

[Paul Miatello, Vice President]

Yes, I mean it'll -- typically it'll pick up a little bit. It's just with August being the back half of summer, families are getting settled for schools and stuff like that. It tends to be a little more quiet then it'll pick up a little more in September/October then obviously you get into the winter months where it declines. So, I think they --

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Industry issue, right?

[Paul Miatello, Vice President]

Yes, it's an industry issue. I think everybody's sort of, you know my understanding is that everybody is sort of seeing the same thing we're seeing. Whether high single digits is the new norm, I can't really comment on that, but I would -- I would say it's definitely down.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

The trend is definitely in that direction.

[Paul Miatello, Vice President]

And it's -- yes, that's going to be the reality, at least for the next little while until some of those other circumstances change. I'll ask Sanjay maybe to add any other color commentary to that that he can.

[Sanjay Ratejay, Vice President of Operations]

Yes, Paul, thank you very much and you very well explained. That's exactly what we are noticing and experiencing and portfolio wide as much we expect it to be higher. People are not moving out because of the reasons Paul mentioned. But every time any of the suites which are turnover, we're achieving over 9%, 9.5% to 9.8% increase in the rent. So we're just doing whatever we can to keep them bringing that up. But you're right, it's in single digits right now.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

I don't even know if I understand what I'm asking here, but I'm going to ask it. The tax cuts and job act, so you've got $3.5 million of unutilized interest expense deduction that they -- what does that mean or do we even need to, it's something that we just can ignore?

[Paul Miatello, Vice President]

I mean at the end of the day it's the major implication and like I'm not going to get into the deferred tax side of it, I mean you know I'm an accountant myself so accountants love that stuff. But the deferred tax it's, you're just setting up the liability for future tax on something you may never sell. So, if you leave all that aside, the major implication of the REIT is like we have a bunch of taxable subsidiaries in the US. We don't pay any tax cause we don't have any taxable income in the US. And we don't foresee that changing for several, several years. We forecast the stuff out, obviously, over the long, long term. And the major implication of the change in -- for the tax reform in the US is that the corporate tax rate has gone down from something like 35% to 21%. And that's important if you're taxable, but again we're not taxable.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

You can shelter it, so it doesn't matter. So you've got -- you'll just have this unutilized expense to offset that you won't need anyway, so okay.

[Paul Miatello, Vice President]

Yes, exactly.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

I'm assuming it's probably a little too early to talk about the 2019 debt maturity at this point?

[Paul Miatello, Vice President]

Yes, those ones don't roll till late in the year. I think it's December. So, yes those are more than a year out. So, yes, too early to be talking -- you know I'm not sure what's going to happen with base rates between now and then. But, yes, those really are the next rollovers for the REIT and they don't happen for over 12 months.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

That's a good ways away.

[Operator]

[Operator Instructions] There are no further questions at this time. Please proceed.

[Paul Miatello, Vice President]

Okay. Thanks, everyone, for joining the Q2 conference call and we look forward to Q3.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.