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 Third Quarter Results Conference Call.[Operator Instructions]This is call is being recorded on Thursday, November 1, 2018.I would now like to turn the conference over to Bob Wright. Please go ahead.

[Robert D. Wright, Vice President]

Thank you very much. As is customary, I will provide comments on the REIT's financial position and performance. Then we will open the door for questions.In terms of our financial position, the REIT completed the third quarter of 2018 with assets totaling CAD 2.9 billion, compared to CAD 2.7 billion in December of 2017. The increase in assets during 2018 was due to the acquisition of a property under development of CAD 15 million, a fair value gain of CAD 134 million and a change in foreign exchange rate during the year having an uplift of approximately CAD 48 million.The REIT finished the third quarter of 2018 with CAD 18 million of cash on hand and CAD 12 million owing the Morguard Corp. under its revolving credit facility. The REIT has a CAD 100-million credit facility which can be drawn on either Canadian or U.S. dollars and which the REIT can use for acquisitions and general corporate purposes.The REIT completed the third quarter of 2018 with CAD 1.3 billion in long-term debt obligations. There was no refinancing activity in the quarter.As at September 2018, the REIT overall weighted average term to maturity was 6.1 years, decreased from 6.2 in the prior year. The REIT weighted average interest rate decreased to 3.48% from 3.5% in December. The REIT continues to make progress in reducing its overall leverage. The REIT debt book -- gross book value improved from 51% in December of last year to 49% in September of this year.Morguard has an IFRS asset management value of CAD 23.75 per unit as at September 30, 2018, compared to market price of CAD 16.50, still reflecting a significant discount to our current trading price.Turning to the statement of income. Net income increased by CAD 17.1 million to CAD 25 million for the 3 months ended September 30, 2018, compared to 2017. An increase in NOI and higher noncash charges to fair value on real estate properties, particularly offset by higher fair-value loss in the Class B units, compared to 2017.Net operating income of CAD 38.2 million for the 3 months ended September 30, 2018, increased by CAD 3 million, or 8.5% compared to the prior year. Proportionate NOI increased by CAD 1.2 million, or 4.1%, to CAD 31.9 million, compared to CAD 30.7 million for the prior year.Interest expense increased by $1.6 million for the 3 months ended September 30 compared to 2017. Excluding the noncash fair-value adjustments, interest expense decreased by CAD 0.8 million.The REIT third quarter performance has translated into basic FFO of CAD 15.5 million, an increase of CAD 1 million, or 7%, from the prior year. On a per-unit basis, FFO was CAD 0.30 per unit for the 3 months ended September 2018, an increase of CAD 0.01, or 3.4%, compared to the 2.9 (sic) [ CAD 0.29 ] per unit in the prior year. The change in foreign exchange rate of 1% per unit had a positive impact.The REIT FFO payout ratio for the 3 months ended September 30, 2018, was 54.2%. In addition, the Board of Trustees of the REIT is announcing an increase in annual cash distribution of CAD 0.02 per unit, an increase of 3.03%. The increase is expected to be effective for the November 2018 distribution, payable in December 2018. This will bring the distribution to CAD 0.68 per unit on an annualized basis from the current CAD 0.66 per unit.Operations. Operationally, the REIT has had a successful quarter, with average monthly rents in Canada increasing to CAD 1,358. This reflects the quality of the Canadian portfolio and translates into 2.9% increase in rent levels from the prior year, while in the U.S., average monthly rents increased by 2.4%, having an average monthly rent of USD 1,231 at the end of the third quarter, compared to USD 1,202 at the end of the prior year.The REIT continues to have strong occupancy, with Canada finishing the third quarter at 99.5%, compared to 98.5% a year earlier. Occupancy in the U.S. continues to improve over the prior year. Occupancy increased to 93.5% from 90.7% in the prior year.Same-property occupancy in the U.S. decreased slightly from 93.7% occupancy reported in June of 2018 resulting in an increase in new supply and free rent concessions offered by competitors.I will now turn the call back over to the moderator, who will open the lines for questions.

[Operator]

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

[Jonathan Kelcher, Analyst]

First question's just on the turnover so far this year. I guess it's about 14% on the Canadian portfolio, and I'm just curious as to how that compares to prior years.

[Unknown Executive]

I can -- yes, I can answer that. Definitely, we are seeing a trend. The turnover is on a decline and is definitely lower than the previous years. The year -- in 2017, we experienced around 20%, and we're finding it's lower this year.

[Jonathan Kelcher, Analyst]

Okay. Would you -- if -- and you're getting roughly 10% on turnovers. Is that something that we can expect going forward?

[Unknown Executive]

Yes.

[Jonathan Kelcher, Analyst]

For the next couple quarters, anyways?

[Unknown Executive]

Yes, absolutely. Our Mississauga property is analyzed. We're getting 12.32% bump in the rent, and in downtown properties, we're getting close to 13%, so between 12% and 13% is what we're managing.

[Jonathan Kelcher, Analyst]

Okay. And then just secondly, what's your -- given where you trade relative to your IFRS value, what's your appetite for acquisitions?

[Kuldip Rai Sahi, Chairman & CEO]

Well -- this is Rai Sahi. Well, we -- I don't want to say appetite. We're always looking at -- there's all kinds of [ product ] available, more in the U.S. than in Canada. And with also kind of reflecting is what is happening to the [ midyear ] to long-term rate, and notwithstanding, we continue to look at it. So we are a little cautious about whether the interest rates are going to continue to climb and whether that will change the pricing. So it's an ongoing thing, so we'll just continue through that, and if there's an asset that we think that we need to [ deploy ], we will. But we'll let you know if we do something. Thank you.

[Jonathan Kelcher, Analyst]

Okay. What about dispositions, or any market set you're currently in that you'd like to exit or reduce?

[Kuldip Rai Sahi, Chairman & CEO]

I don't think there's anything in the U.S. at this stage we are looking at. At this stage, we've made no decision to -- as to any potential disposition of -- out of Canada.

[Operator]

Your next question is from Dean Wilkinson from CIBC.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Rai, if I could just continue on with Jon's question there, you look at the stuff you've got in Canada, the stuff that's in Mississauga there. I -- you take that out to the market, I mean, I don't think people would be shocked if that garnered something with a 3 in front of it in terms of a cap rate. And you don't want to part with good assets, but the difference between what you could pick up stuff down in the states for -- is that something you think about, or is it just, hey, the valuation's going to continue to increase on those Canadian assets, and we'll let the market take it where it takes it.

[Kuldip Rai Sahi, Chairman & CEO]

Well, we look at it a little differently than just because you think you can get 3 or [indiscernible] cap is not [indiscernible]. Some of the assets in Mississauga over there are -- they're core assets. So it's not just that we want, [ crave ], something in the U.S. I mean, as you know, availability of Canadian assets are pretty [ scarce ], so I don't think just for the sake of that, selling at a lower cap rate versus buying at a higher cap rate is a deciding factor for us. So answering the question, we have no interest in selling the Mississauga assets.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Okay, great. And then just when I look at sort of the margins that you get off of those assets, and I look at sort of some of the other Canadian apartment peers and sort of that differential in the margins, and I know you don't sort of have insight into how they run their financials, but do you sense that your margin differential being a little bit lower is that you're perhaps a little more conservative when it comes to expensing things like R&M, where others might be capitalizing a little bit more of that? Or do you have any insight into sort of those differences?

[Kuldip Rai Sahi, Chairman & CEO]

Well, the truth of the matter -- this is Rai Sahi. I don't think we'll waste time worrying about what other people do, whether we are expensing or not. I -- we run the business as efficiently as we can, and not worrying about what other people are doing.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Fair enough, fair enough. And then I guess if you're going to see the margin or the turnover continue to trend lower, with a lower amount of turn, you have less expenses associated with turns, so it's likely that the margin actually does sort of tickup from here?

[Kuldip Rai Sahi, Chairman & CEO]

I don't know. I've got nothing more to add.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

I guess we'll wait and see.

[Operator]

Your next question comes from Yash Sankpal from Laurentian Bank.

[Yashwant Sankpal, Analyst of Real Estate Investment Trust]

Just on your U.S. NOI margins, year-over-year they were down, and I think it was partly because of the higher turnover rate and some other things. So maybe you could add some color around that? Like, what exactly happened? Is it related to incentives that you're offering? Is it related to new supply in the market?

[Kuldip Rai Sahi, Chairman & CEO]

John, do you want to handle that?

[John Talano, Vice President of Operations]

Sure. Our portfolio in general went -- our occupancies dropped earlier this year. So many of that vacancy we have eaten up over the last several months. So we're now 94% occupied and 95% leased, but in the quarter, we had to make all those units ready, and we had a very active quarter as well, so more concentrated turns within this quarter where lots of folks moved right over the summer months. Sometimes folks move more in the spring and fall, but we saw a higher concentration in that 3-month period. And that, coupled with the utilities, just drove those expenses up over this quarter. So we expect it to be normalizing. It's definitely normalized now, and we expect it to be normalized through Q4, if that helps.

[Yashwant Sankpal, Analyst of Real Estate Investment Trust]

And how is the new -- how are you guys dealing with new supply in your markets? Are you guys still seeing it? Are you seeing it?

[John Talano, Vice President of Operations]

It's market -- it is market by market. There's definitely new supply in D.C. and in Chicago that we're dealing with every day. I would say in Chicago, we're in a much better place than we are -- than we were this time last year. We also see the development pipeline starting to dwindle, so we are still dealing with that, but we expect it to continue to improve. And the demand for apartments is strong. The interest rates creeping up a little bit has made the housing market weaken a little bit as well, which we saw very recently. So we're confident that it will continue to improve.

[Yashwant Sankpal, Analyst of Real Estate Investment Trust]

Okay. And where do you think your U.S. occupancy will be by year-end?

[John Talano, Vice President of Operations]

I can't speculate that.

[Yashwant Sankpal, Analyst of Real Estate Investment Trust]

Be higher, be lower from here?

[John Talano, Vice President of Operations]

We expect it to stay in the same range, where it is today.

[Operator]

Your next question is from [ Hal Dash ] from Seashell Investments.

[Unknown Analyst]

Mr. Sahi, the last quarter, there was a couple of apartments purchased by Morguard Corp. in Boynton Beach, Florida. Why were those not purchased by the REIT? And is there an intention that those will be -- will later be sold to the REIT?

[Kuldip Rai Sahi, Chairman & CEO]

Well, some of these were condo jobs, and John, do you want to [indiscernible] But really, we don't -- or we -- sometimes assets fit in corp as opposed to the REIT because they've got some work to be done.

[Unknown Analyst]

Well, these were brand new, I believe, Mr. Sahi.

[John Talano, Vice President of Operations]

The Santorini -- yes, Santorini itself was a lease-up, so it was currently unoccupied, so we didn't feel like it was a good fit for the REIT acquisition.

[Unknown Analyst]

There was 2 of them.

[John Talano, Vice President of Operations]

Right, the [ Skya ] was a broken condo acquisition of 125 units, and again, that was attached to the deal with Santorini. They are related and purchased from the same party. But again, that was a bit of a complicated transaction where we're dealing with the lease-up as we speak.

[Unknown Analyst]

So it -- just a quick question, then. Is there the possibility they will be then purchased by the REIT from Morguard?

[Kuldip Rai Sahi, Chairman & CEO]

I think we will look at that, the -- once it's stabilized, whether that should be the case or not.

[Operator]

[Operator Instructions]

[Kuldip Rai Sahi, Chairman & CEO]

There's nothing else?

[Operator]

There are no further questions at this time. You may proceed.

[Kuldip Rai Sahi, Chairman & CEO]

Well, thank you very much, and we shall talk to you next quarter. Thank you. Thank you for attending.

[Robert D. Wright, Vice President]

Thank you.

[Unknown Executive]

Thank you.

[John Talano, Vice President of Operations]

Thank you.

[Operator]

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