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's Second Quarter 2021 Results Conference Call. [Operator Instructions] This call is recorded on Thursday, July 29, 2021.I would now like to turn the conference over to Mr. Rai Sahi. Please go ahead.

[Kuldip Rai Sahi, Chairman & CEO]

Thank you very much. Chris, why don't you go ahead and introduce everybody who's on.

[Christopher A. Newman, Chief Financial Officer]

Thank you, Rai. With us as well is Paul Miatello, Angela Sahi and John Talano and also Patrick Seward. 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 second quarter of 2021 with total assets amounting to $3.1 billion, unchanged compared to December 31, 2020. The REIT finished the second quarter of 2021 with approximately $18.1 million of cash on hand and $97.8 million available under its $100 million revolving credit facility with Morguard Corporation. The REIT completed the second quarter of 2021 with $1.2 billion of long-term debt obligations. And as at June 30, 2021, the REIT's overall weighted average term to maturity was 4.3 years, a decrease from 4.8 years at December 31, 2020, having a weighted average interest rate of 3.45%.The REIT's debt to gross book value ratio improved to 41.4% at June 30, 2021, down compared to 42.8% at December 31, 2020. The REIT's IFRS net asset value at $28 per unit as at June 30, 2021 compared to the current market price of approximately $17.50 reflects the compelling entry point for investors.Turning to the statement of income. Net income was $20.3 million for the 3 months ended June 30, 2021 compared to $19.3 million over the same period in 2020. The $1 million increase in net income was primarily due to a higher fair value gain on real estate properties of $9.4 million relative to the gain recorded during 2020, an increase in deferred tax expense of $4.6 million and a decrease in NOI of $3.9 million.IFRS net operating income was $37.4 million for the 3 months ended June 30, 2021, a decrease of $3.9 million or 9.4% compared to 2020. The change of foreign exchange rate amounts to $3 million of the overall $3.9 million variance to Q2 2020.On a same-property proportionate basis, NOI in Canada decreased by $1.2 million or 8.7%, mainly due to higher vacancy. NOI in the U.S. decreased by USD 0.1 million or 0.9% as higher operating expenses nearly offset an increase in revenue resulting from higher AMR and lower vacancy. And the change in foreign exchange decreased NOI by $2.6 million.Interest expense decreased by $1.1 million for the 3 months ended June 30, 2021 compared to 2020, primarily due to the change in FX, as the strengthening of the Canadian dollar decreased interest expense on U.S. mortgages. The REIT's second quarter performance has translated into basic FFO of $16.1 million, a decrease of $3.2 million or 16.5% when compared to 2020. And on a per unit basis, FFO was $0.29 per unit for the 3 months ended June 30, 2021, a decrease of $0.05 compared to the $0.34 per unit in 2020. The decrease in FFO per unit was due to the following: a change in the foreign exchange rate on a same-property proportionate basis had a $0.03 per unit negative impact; and in local currency, a decrease in NOI from increased vacancy, partly offset by a decrease in interest expense and trust expenses at a $0.015 per unit negative impact. The remainder of the variance to last year was due to nonrecurring other income recorded during the second quarter of 2020, which had a $0.015 per unit negative impact. The REIT's FFO payout ratio was 61% for the 3 months ended June 30, 2021, a very conservative level, which allows for significant cash retention.Operationally, the REIT's average monthly rent in Canada increased to $1,520 or a 4.5% increase compared to 2020, reflecting the quality of our Canadian portfolio. During the year, the Canadian portfolio turned over 5.2% of total suites in Canada and achieved 14.2% AMR growth on suite turnover. While in the U.S., same-property AMR increased by 0.8% compared to 2020, having an average monthly rent of USD 1,436 at the end of June 2021. The REIT's occupancy in Canada finished the second quarter of 2021 at 91.8% compared to 97.5% a year earlier. Occupancy decreased in Canada due to continued lower leasing traffic, lower immigration levels as well as 2 properties impacted by university closures. In addition, occupancy at the REIT's GTA properties have experienced a 4 to 5 basis point decline as management's focus has been on maintaining existing rent levels as we believe the higher vacancy will recover as the economy reopens and the number of Canadians fully vaccinated increase.Same-property occupancy in the U.S. of 96.8% at June 30, 2021, higher compared to 93.6% at June 30, 2020. And reached optimum levels as most of the REIT's U.S. submarkets have rebounded from previous COVID-19 restrictions and as the U.S. economy has recovered.During the 6 months ended June 30, 2021, the REIT's total CapEx amounted to $11.9 million, that included exterior building and revenue-enhancing including improvements. Overall, in order to preserve liquidity, the REIT scaled back most of its revenue-enhancing CapEx and continue to focus on maintenance CapEx. And lastly, at July 27, 2021, the REIT collected 98.7% of second quarter rental revenue and approximately 95.6% of July 2021 rental revenue which is materially in line with historical collection rates.I'll now turn it back over to the moderator who will open up the lines for questions.

[Operator]

[Operator Instructions] Your first question comes from Liyan Chen with iA Capital Markets.

[Liyan Chen]

First one for me. Just in general, with regards to overall operating expenses in the U.S., can you comment on the increase in repair and maintenance expenses. What should we be expecting on that front for the rest of 2021?

[Christopher A. Newman, Chief Financial Officer]

Yes. John, can you take care of that question?

[John Talano, Vice President of Operations]

Sure. Well, there were 2 things going on that occurred. One is through the pandemic, we slowed what we were doing inside the residence units. So we were only doing emergency work orders. So when things opened up, we also -- we're getting back into our residence units and making those repairs. So that was a big part of it. That work has all been complete.The other issue is we have had a huge influx in our occupancy, and we had to get those units ready as well. And that was a bump in our make-ready and turn costs for maintenance as well. So those things have already happened. And fortunately, we've seen our occupancy go higher now than to our pre-pandemic levels. So we're at a point now where we don't really have anything to lease. So those expenses, we expect to go down, especially because our turnover in general has gone down as well over the last year.

[Liyan Chen]

That's great. And last one for me. Just looking at the Illinois market, can you give more color regarding the current dynamic between lower rental rates and higher occupancy? And what's the strategy going forward?

[John Talano, Vice President of Operations]

Well, we are fully leased in Chicago. I believe all of our buildings are close to or either at or above 99%. We do our renewals roughly 90 days in advance. So there was a bit of a lag between when we started getting the rush back into the city, and that's exactly what it was. Our occupancies increased significantly. And Chicago still has a significant amount of supply, but our rates were lower specifically at the Marquee where we're having significant occupancy issues. But as that leased up, that building now is also 99% leased. We have aggressively pushed our rents as well. So upon turnover, and we expect those buildings to be in the 40% range annually, we are getting some significant bumps in rent and clawing that back.

[Operator]

Your next question comes from Lorne Kalmar with TD.

[Lorne Kalmar, Associate]

Just wondering on the $110 million of our financing proceeds, what's sort of the intended -- or some of the uses that you guys have discussed. If you could maybe give a little more color that would be great.

[Christopher A. Newman, Chief Financial Officer]

Yes. Right now, we're just working on securing the increase in financing proceeds. But I'll turn it over to Rai to speak about, I guess, it ties -- your question ties to acquisitions potentially. Right now, there's something in immediate, but Rai can elaborate on that.

[Kuldip Rai Sahi, Chairman & CEO]

Yes. We're looking more in the U.S. I mean we're also looking in Canada. But in Canada nothing seems to make sense. And we will continue to look in the U.S. Patrick, do you want to add anything to that?

[Patrick Seward]

No. As we said, traditional markets are in play and the U.S. is very active, and we see lots of potential.

[Lorne Kalmar, Associate]

Okay. And then -- and maybe just kind of following on that. What are you guys seeing in the U.S. from an acquisition cap rate perspective. Have they been holding it in or they've been taken downwards?

[Patrick Seward]

COVID had short term -- from what we see in Toronto down south, John will have his own views given the operating portfolio. But the third-party market was showing a wee bit of COVID weakness into the first 6 months of the pandemic. And that created a bit of uncertainty. There have been a few opportunities, not necessarily at below -- not necessarily at above-market yields but you're getting better quality assets at slightly lower dollar per pound pricing. But yields are still between 3.75% and 4.75% depending where you are and the level of quality and your rent levels.

[Lorne Kalmar, Associate]

Okay. Fair enough. And maybe last one for me, switching gears a bit. With the U.S. above, I'd say, the high end of your target occupancy range, and you guys are expecting to start pushing rent. How do you kind of see that translating into same property NOI growth over the balance of the year?

[Christopher A. Newman, Chief Financial Officer]

John Talano?

[John Talano, Vice President of Operations]

Well, the main increase that we're going to see -- again, now our renewals go out 90 days in advance. So if you think about it, we're going to be putting out -- or we have our renewals for October already. Those we have pushed in general between 3% and 6%, depending on the market. But the big positive impact will be from the full occupancy and lower turnover that we're expecting through the end of the year. So we had to spend a lot of money getting the units ready and we had a huge influx in Q2, but we're going to be able to enjoy that over the next several months.

[Lorne Kalmar, Associate]

So would it be fair to say you guys think you can get back to positive same-property NOI growth in the U.S., excluding the currency impact? In Q3, sorry, I should say.

[John Talano, Vice President of Operations]

I think we're very close. I don't want to predict what will happen. I feel like we are getting very close. Things look very good. But we're still cautiously optimistic, let's put it that way.

[Operator]

Your next question comes from Matt Logan with RBC.

[Matt Logan, Analyst]

Perhaps just following up on a couple of Lorne's questions. When you guys say you're cautiously optimistic, where would the caution be across the portfolio? And maybe where would the optimism be?

[Christopher A. Newman, Chief Financial Officer]

Maybe, John, we can start with you on the U.S. side.

[John Talano, Vice President of Operations]

Sure. Again, the optimism comes from the influx of -- or I guess, our increases in occupancy. We have never enjoyed the occupancies that we have today. Really, in my 20-plus years, I have 12 properties now that are literally 100% leased, which I've never seen before. So that is all very good news. At the same time, we have a housing shortage across the U.S. So single-family home prices are skyrocketing, and that is making a lot of what would be homeowners sell their homes to reap those profits.Those folks, too, have moved into our apartment communities. So I expect that to continue to be a positive impact. And from a risk profile, we're definitely dealing with the Delta variant in the southern states. At the same time, that is a nonvaccinated-individuals issue. And I personally don't believe that, that will affect the economy over time. but you never know. And with that variant out there and the possibility of others, we're just being cautiously optimistic.

[Matt Logan, Analyst]

Given the occupancy levels of 98%, do you think you'll start to push harder on rent going into the back half of the year?

[John Talano, Vice President of Operations]

We already have. Now we're at 96% occupied. We're close to 99% leased. But those are very strong numbers for us. And we use a revenue management software that will automatically push those rents as we reach those higher occupancies. So they're there, and we're pushing between 3% and 6%. But it's something we haven't seen before and it happened so quickly. We just want to be careful.

[Matt Logan, Analyst]

Given that the U.S. recovery seems to be leading what's going on in Canada, what readthroughs can we take away for the Canadian assets. And maybe taking a step back, when do we think we can get back to pre-pandemic levels of NOI in both Canada and the U.S.?

[Christopher A. Newman, Chief Financial Officer]

Angela, can you [ attest ] to that?

[Angela Sahi, Senior VP of Corporate Development & Director]

Sure. So I think we're actually with the recent openings in Ontario, we're actually seeing some positive traffic. And we have a bunch of move-in scheduled for August, September, October, [ Where ] currently have 156 suites that have been leased in the portfolios or -- and about 160 move-outs. So we're catching up actually at this point. And our occupancy still remains strong at certain properties like Margaret Place is almost 100% occupied. Rouge Valley is almost 100% occupied. Meadowvale Gardens is 96%, 97%, Downsview Park is 100%. We're noticing -- obviously, the U.S. as a precedent, but we also have other properties in our portfolio outside of MRG downtown, and we're noticing a heavy influx of the foreign students coming back. So one of our properties downtown was in a similar situation to 160 Chapel and Square 104, where they're also student based, but we're 90% occupied there within 2 weeks. So we're seeing a lot of positive activity. And I think as long as things remain open and the economy picks up and immigration picks up, we'll have a lot more units leased up in the next couple of quarters.

[Operator]

Your next question comes from Dean Wilkinson with CIBC.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

This might be a question for Angela, maybe, and it's similar to what Matt just asked. When you look at those Canadian -- the Canadian portfolio occupancy levels, would it be fair to say that you may have held back on some of the leasing because the mark-to-market opportunity is a lot bigger than say what you see in the U.S. where you've actually kind of hit sort of the optimal occupancy levels across the portfolio?

[Angela Sahi, Senior VP of Corporate Development & Director]

Well, we've held rent. So if that's kind of what you're asking in terms of we haven't...

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Yes.

[Angela Sahi, Senior VP of Corporate Development & Director]

Yes, we've taken -- like we will run specials on certain units just to get traffic in, but we've held rent. So could we have leased more if we were to reduce rent? Sure. But the idea is because we're rent controlled in Ontario. We just -- we did hold our rents. And we're seeing it actually -- the downtown property I'm talking about, we're actually able to increase rents above pre-COVID market on some of our units. So it's actually a good thing that we did hold the rents.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

That's where I was going with the question, thinking that there's an equivalent kind of mark-to-market opportunity as if it was [ on a roll ], but then it's obviously that much bigger because anything greater than 0 is infinitely higher. So that does answer that. That's it for me.

[Operator]

Your next question comes from Yash Sankpal with Laurentian Bank.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

I just want to talk about the -- about the tenants that are rushing back in your U.S. buildings. Are these the same folks that used to rent your buildings? Or has the profile of the tenants changed?

[John Talano, Vice President of Operations]

I would say, in the most -- for the most part, it is the same type of tenant. Where we gained -- or let's say, where we had our largest vacancies in downtown Chicago and in D.C., those are generally folks that left the city because either the schools were closed or they are young professionals that all the amenities downtown became useless. They can't have access to them. So those folks moved out to the suburbs or back home. And quite frankly, I think a lot of our tenants were done with living in their parents' basement. And that's why we saw the explosion of activity. I actually toured many of our -- well, all of our assets in Chicago and D.C. recently. And the cities are vibrant, people are out. It's a very normal situation and environment. And that's what brought the people back. So I think with anywhere in the cities that were closed down. There is an absolute pent-up demand for those amenities that folks haven't had access to in a year.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Right. Okay. Where is your Canadian occupancy at this point?

[Christopher A. Newman, Chief Financial Officer]

Angela, can you answer to that?

[Angela Sahi, Senior VP of Corporate Development & Director]

We're basically just where we are at Q2. It hasn't really gone up much because most of the move-ins for the last few weeks have been for August, September and October. So if you're kind of wondering, it has gone up significantly in -- for this quarter, not yet is what I would say. It's going to be flat from Q2 currently today. But as we get more leases, hopefully, that should improve over the next quarter.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

So you have lease suites but they're not occupied. Is that what you're saying?

[Angela Sahi, Senior VP of Corporate Development & Director]

Exactly.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Okay. And in terms of student leasing, at this point, is it at the same level that you -- as in the past or is it lower than...

[Angela Sahi, Senior VP of Corporate Development & Director]

Yes. So basically in Edmonton, the universities have announced openings, so we seem to be leasing pretty strongly over there. We've had 20 leases already for August and another 20 for September. And similar in Ottawa. But Ottawa seems to be a little bit mixed in terms of which faculties open and which isn't. They're a little bit cautious, I guess, in their opening. So it will all depends. Like I know from downtowns the UT campus is open. So that's why we've seen a huge influx over there. So it will all depend on the announcements that are made and how many students can come back.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

And are foreign students booking [indiscernible]?

[Angela Sahi, Senior VP of Corporate Development & Director]

It's all -- yes, it's foreign students that we're talking about that are coming back.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Okay. And Chris, based on your cash flow statement, your tenant incentives have doubled this quarter as compared to Q1. So just wondering where those incentives are being applied? Are they in the U.S.? Or in Canada? Just maybe some color there.

[Christopher A. Newman, Chief Financial Officer]

Yes. They've gone up just in general, just because leasing activity has gone up during the quarter, especially in the U.S. It's not a very large number from a bigger picture. I believe can -- maybe Angela and John can touch upon the use of concessions. I don't think it's widely used, and it's probably a few units that have been on the market for a little longer than normal. But I believe, John, can we start with you? I think it's predominantly U.S., on the concessions, right?

[John Talano, Vice President of Operations]

So yes, I would say in Chicago, as we're leasing up, we're competing with a significant number of new builds. So those properties are generally offering not just 1 month, but 2 months free in the lease-ups. So we were competing with that as we were leasing up. And that's where we were using most of our concessions in Chicago. But virtually all of those are now done.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Right. And John, what do you think is your optimum -- I think in the past, you had said 95%. Do you think you would like to maintain that level? Or do you think this elevated level could be maintained for some time.

[John Talano, Vice President of Operations]

Well, yes, we are actually looking at it very closely. You're talking about between 95% and 96%. We do have lower turnover. And it's the turnover cost that can be significant when you're turning over these units. So we're trying to balance that out. We absolutely do not want to push folks out and increase our overall turnover. But at the same time, we are bringing those folks up that are well below market significantly. So our [ Rentmax ] software that we use could bring people up between 6% and 8% if they're that far behind market. And our market rates are increasing. And today, even in Chicago and D.C., they are above the pre-pandemic levels. Now that's not our AMR obviously, but those are our asking rents. So those are coming up very quickly as well.

[Operator]

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

[Christopher A. Newman, Chief Financial Officer]

Okay. Thank you very much, everyone.

[Kuldip Rai Sahi, Chairman & CEO]

Talk to you next quarter. Thank you.

[John Talano, Vice President of Operations]

Bye.

[Angela Sahi, Senior VP of Corporate Development & Director]

Thank you.

[Operator]

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