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 Third Quarter 2021 Results Conference Call. [Operator Instructions] Also note that this call is being recorded on Thursday, October 28, 2021. And now I would like to turn the conference over to Mr. Rai Sahi.

[Kuldip Rai Sahi, Chairman & CEO]

Thank you. I'm going to pass it on to Angela. Do you want to introduce the rest of [ the people ]?

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

We have Beverly Flynn here, myself, Chris Newman in person. And then on the phone, we've got Paul Miatello and John Talano.

[Christopher A. Newman, Chief Financial Officer]

Okay. Thanks, Angela. And as is customary, I will provide comments on the REIT's financial position and performance. In terms of our financial position, the REIT completed the third quarter of 2021 with total assets amounting to $3.3 billion compared to $3.1 billion in December 2020. The increase is mainly due to a fair value increase on the REIT income producing properties. The REIT finished the third quarter of 2021 with approximately $20.5 million of cash on hand and $84.6 million available under its $100 million revolving credit facility with Morguard Corporation. The REIT completed the third quarter of 2021 with $1.2 billion of long-term debt obligations. And as at September 30, 2021, the REIT's overall weighted average term to maturity was 4.1 years, a decrease from 4.8 years at December 31, 2020, and having a weighted average interest rate of 3.45%. The REIT's debt to gross book value ratio improved to 40.2% at September 30, 2021, down compared to 42.8% at December 31, 2020. The REIT's IFRS net asset value of $29.80 per unit as at September 30, 2021 compared to the current market price at a little over $18 reflects a compelling entry point for investors. And turning to the statement of income. Net income was $86.7 million for the 3 months ended September 30, 2021 compared to $53.5 million over the same period in 2020. The $33.2 million increase in net income was primarily due to a higher fair value gain on real estate properties of $55.2 million relative to the gain recorded during 2020 and was partially offset by an increase in deferred income tax expense of $19.6 million and an increase in fair value loss in Class B LP units of $6.5 million. IFRS net operating income was $37.1 million for the 3 months ended September 30, 2021, a decrease of $1.7 million or 4.3% compared to 2020. The change in foreign exchange rate amounts to $1.4 million of the overall $1.7 million variance to Q3 2020.On a same-property proportionate basis, NOI in Canada decreased by $0.3 million or 2.4%, mainly due to higher vacancy, partially offset by growth in AMR. NOI in the U.S. increased by USD 0.1 million or 0.7% as an increase in revenue from AMR growth and lower vacancy, but partially offset by higher operating expenses and the change in foreign exchange decreased NOI by [ 1.1 points ]. interest expense decreased by $0.5 million for the 3 months ended September 30, 2021 compared to 2020, primarily due to the change in foreign exchange as the strengthening of the Canadian dollar decreased interest expense on U.S. mortgages. The REIT's third quarter performance has translated into basic FFO of $16.2 million, an increase of $0.1 million or 0.4% when compared to 2020. And on a per unit basis, FFO was $0.29 per unit for the 3 months ended September 30, 2021, unchanged compared to Q3 2020. As the following items offset each other, a change in foreign exchange rate had a $0.01 per unit negative impact and a decrease in other expense which was largely a result of a nonrecurring write-off during 2020, had a $0.01 per unit positive impact. The REIT's FFO payout ratio of 60.9% for the 3 months ended September 30, 2021 is a very conservative level, which allows for significant cash retention. Operationally, the REIT's average monthly rent in Canada increased to $1,530 or 3.3% compared to 2020, reflecting the quality of our Canadian portfolio. During the year, the Canadian portfolio turned over 10.6% of total suites in Canada and achieved 11.3% AMR growth on suite turnover. While in the U.S., same-property AMR increased by 4.1% compared to 2020, having an average monthly rent of USD 1,486 at the end of September 2021. REIT occupancy in Canada finished third quarter of '21 at 92.7% compared to 96.4% a year earlier. Occupancy decreased in Canada due to the impact of past-dated home restrictions, which disrupted normal leasing patterns. As the administration of vaccinations continues to progress across the country and as restrictions are lifted, we continue to see increased leasing activity and number of suites leased. In addition, occupancy in the GTA was impacted by lower immigration levels, the increased number of suites on market increased -- the increased number of suites on the market from existing and new supply and the previous province-wide stay at home order. Same-property occupancy in the U.S. of 96.4% at September 30, 2021 was higher compared to 93.3% at September 30, 2020 and maintained optimum levels as the REIT -- as most of the REIT's U.S. submarkets are outperforming pre-pandemic levels. The REIT's redevelopment property, 1643 Josephine Street, New Orleans, Louisiana, reached stabilized occupancy and is currently 90.4% occupied and 98.2% leased. The repositioned asset further improves the overall quality of the portfolio having an AMR of USD 1,822. During the 9 months ended September 30, 2021, the REIT's total CapEx amounted to $19.3 million that included exterior building and revenue-enhancing in-suite improvements, and we continue to ensure we maintain the structural and overall safety of our properties. And lastly, as at October 26, 2021, the REIT collected 98.4% of third quarter rental revenue and approximately 95% of October 2021 rental revenue, which is materially in line with historical collection rates. I will now turn it over -- the call back to the moderator, who will open up the line for questions.

[Operator]

[Operator Instructions] And your first question will be from Lorne Kalmar at TD Securities.

[Lorne Kalmar, Associate]

Just first on the U.S. portfolio. It looked like top line revenue was pretty solid there, backed by some good rent growth in occupancy. But the margins seem to be kind of at the low end of the historical range for the portfolio. Can you maybe give us a little more color on that and sort of what your expectations are for 2022?

[Christopher A. Newman, Chief Financial Officer]

Yes. No problem. I'll turn it over to John, who's our VP, Operations in the U.S.

[John Talano, Vice President of Operations]

Sure. Yes, we are raising rent actually significantly since really about -- it was last quarter when we started aggressively. We have taken some expense hits, biggest is property taxes, which we saw a big increase this quarter. That and insurance are 2 major drivers. We do have some inflationary issues with salaries as well as access to materials. We think those are temporary, of course. But we've been working really hard to adjust rents with these costs going up. And anecdotally, our asking rent really across the portfolio today, if we exclude our urban markets, really Chicago and D.C., if we exclude those, our asking rent, this is not AMR, but what we're asking today, is actually 34% higher than what it was pre-pandemic. That hasn't caught up. But because we are very full, we are able to increase those rents, and we are pushing AMR wherever we can. So we're catching up, and we believe a lot of it will normalize. It's really just those big property tax hits that we're managing to now.

[Lorne Kalmar, Associate]

So would it be fair to say that as these -- as you guys start getting these rents, the margin, we should see some margin expansion? Obviously, I know you guys don't control the property tax side of things.

[John Talano, Vice President of Operations]

Yes. We're working at it. We're getting those rents, and our occupancies even going into winter are stronger than they've ever been. So it's so far working out well.

[Lorne Kalmar, Associate]

Okay. And then maybe turning to the Canadian side. I know you guys -- looked like occupancy ticked up quarter-over-quarter, which is good to see. Specifically at the 2 buildings at Ottawa and Edmonton that have, I think, I believe, a lot of student or cater to the student population, what sort of leasing activity have you guys seen there?

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

So -- it's Angela. So over the summer, that picked up quite a bit. We were -- I think in August and September, we had like 6 new leases at each of those properties. So we had a significant level of activity. However, both locations and universities there are not fully open yet, so there's just a couple of faculties. And hoping in January, we'll have some more restrictions lifted and in which case, we should pick up some more leasing activity there.

[Lorne Kalmar, Associate]

Okay. And maybe more broadly, are you guys starting to see things rebound in a meaningful way across -- on the Canadian side?

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

We are. We are. As restrictions are opened up, we literally see immediate response with leasing activity. So even now, as immigration has just recently started to open up, we're getting a lot of feedback from young professionals from abroad and the IT groups and things like that, which is great. As offices opened up, we're seeing people wanting to go back into some of those core areas like in Ottawa, for example, and even Edmonton, just to have some face-to-face interaction with employers. So that's key. So we're hoping for some more of a positive outlook for next quarter.

[Lorne Kalmar, Associate]

Okay. And then just lastly. I mean, I think the [ game ] proposed typically 97% plus occupied. When do you guys think you get back to that? Because there's no doubt you will.

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

That's really difficult to predict. I think a lot of it depends on everything going back to normal, right? Like I think things have been pretty quiet kind of in the downtown cores, in the malls, in the offices. So once -- I think the U.S. had a much quicker rebound because the restrictions lifted faster, and that would be kind of a direct correlation. As we open up our economy, I think that we'll bounce back to that pre-COVID level of occupancy.

[Operator]

Next question will be from Matt Logan at RBC.

[Matt Logan, Analyst]

Apologies for the background noise here. Wondering if you could provide a little bit of color on your cap rates. We've seen fairly material moves downward in the markets, but have seen very little movement in the REIT's cap rate. So any commentary on what your expectations are going forward would be great.

[Christopher A. Newman, Chief Financial Officer]

Yes. Maybe we can start, John, maybe a little bit of color on the U.S. on the cap rate. And I can speak quickly to Canada. There is obviously still the impression of cap rate pressure of compression. So we're continually looking at the markets in Canada to see if there's a trade that our internal valuations department will consider, if there's any further compression needed. In the U.S., a little more dynamic. I think John can add some value there.

[John Talano, Vice President of Operations]

From an acquisition perspective, it is certainly very frothy if you are a seller in virtually all our markets. So we have seen a little more compression even from last quarter, and it has not really flown up. I think there is a demand for housing. In general, the single-family home market has been so strong, and there has been a frenzy for so many months. It's pushed folks to sell their homes, which have made those homebuyers actually become renters, and they're renting with us. And that just has really pushed up the markets and is even affecting cap rates for new acquisitions as well.

[Matt Logan, Analyst]

Good color. In terms of your overall NOI, you mentioned that the rents were materially above pre-pandemic levels. excluding some of the urban assets. But if we just kind of think about the NOI, would the portfolio be operating above pre-pandemic levels on average in the U.S. today?

[Christopher A. Newman, Chief Financial Officer]

John, maybe you could speak. I think we're pre-pandemic. I believe, in the U.S. we're more or less, if you kind of flip back to our NOIs prior to 2020. I think we've regained any ground loss in the Canada, and that's because of the sharp recovery. But in Canada, we're still tracking and trending up to where we reached our highs in Canada. And that's obviously because of our 98%, 99% occupancy in the past. So it's really contingent upon the vacancy and the recovery.

[John Talano, Vice President of Operations]

Yes. I would say, too, in our markets, I mentioned the urban markets, our occupancy has dropped significantly, I would say, worse than what you guys have seen in Canada. And in Chicago, specifically, that's a big market for us, there was a significant amount of supply on top of that. So our peers were really dropping rates, offering huge concessions and occupancies were still falling. So rents came down. I think we were down roughly 12% from pre-pandemic levels. What happened was it rebounded so fast, we couldn't keep up. So our rents, our rents have rebounded very quickly, but we have to have renewal rates out there 120 days ahead of time. So that didn't allow us to push rents again on our renewals. And that's why we're -- there was a lag there. But I think we're in Chicago, specifically, roughly about 6%, so below where we were. But our asking rents are well above that today.

[Matt Logan, Analyst]

Great color. And maybe one last question for me on the Canadian portfolio. Where would you say like the leasing demand or the occupancy has trended after the quarter? And when we think about January and students potentially coming back, could you see an extended leasing season this year?

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

Yes, I think definitely. I think if the students come back in January and also, as I mentioned, that immigration picks up, and as the offices require more in face, person to person activity, we could see a bigger recovery for next quarter.

[Operator]

Next question will be from Yash Sankpal at Laurentian Bank.

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

Just on the U.S. portfolio. The 34% number, rent, 34% above the pre-pandemic level. John, what -- I mean I understand the speed of the demand was very fast and everything, but how much more room do you think is there in this rent inflation?

[John Talano, Vice President of Operations]

Well, again, these are our asking rents on the units that are available today, and we're 96% to 97% occupied across the portfolio. We are absolutely getting them, and our trends are still good. it is a concern, but there's a lot of runway because these -- that number is basically what we're asking this month, right? So you're talking about a very small percentage of the portfolio that is getting that rate, but it provides us a lot of room for our existing residents upon renewal. So it's not just us, but when the competitor next door has that rate that is 30% higher, the resident sees that they have a good deal, even if the rents go up 8% or 10%, and they'll stay. So there's certainly some significant runway there and it will absolutely normalize. It's just we are grabbing it as we can, so that we can keep up with some of the expenses that we're seeing. And it's necessary, so we're doing it.

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

And I know this is a very basic question, but what -- how long do you think this demand will continue? What do you think will normalize this demand, in other words?

[John Talano, Vice President of Operations]

Well, I will -- I would say a lot of it relates to the single-family home frenzy that we saw over the summer. It is absolutely relaxed. So the folks that sold their homes have to rent. This will continue on for a good 6 months to a year. But it also ties to the single-family home demand and the lack of supply. And it's not just lack of supply. It's a lack of not a supply of homes, but it's a lack of supply of everything, construction materials, appliances, all of those things have played a -- made a huge impact on all of those markets. So I don't see that normalizing in the immediate term. That those supply chains and all those issues, I think, will exist for 12 months to 2 years, I can't predict that.

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

Okay. That's good color. Where do you think your occupancy [ will end ] by year-end?

[John Talano, Vice President of Operations]

Even with our rent growth, we have not seen the normal turnover that we would expect in the winter months. In our northern markets, Chicago, D.C., traffic absolutely does slow in the winter. Our leasing activity slows in the winter, but we still had move-outs. But this year is different. We have -- because we filled up over the summer, a lot of those folks just moved into our buildings. They just started jobs. They're back in the cities, enjoying all the amenities that are now open again. And we're seeing some reduced turnover. I believe in those markets, because our rents are low, we're going to take a little bit of a different tact and accept a little vacancy, keeping our rents high over the winter months because we believe that the demand in the summer or spring and summer will also be strong. So we're pretty bullish.

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

Okay. And Chris, this one is for you. Have you locked the rate on the -- I'm assuming you have locked the rate, but what is the rate you locked at on the 4 mortgages?

[Christopher A. Newman, Chief Financial Officer]

So we're close. So we'll provide an update shortly. We're moving through the process, and we're close to having a commitment for end rate locking.

[Operator]

Next question will be from [ Mike Shimek ], Investor.

[Unknown Shareholder]

My name is [ Mike Shimek ], I'm a private investor [indiscernible], and I had a fairly simple question, which should be simple, but kind of confused. But I was wondering what the net asset value per share is and couldn't find it in the MD&A, maybe I miss it. And when I search online, I get like 5 different numbers from all kinds of different sources, and it seems to be an area of confusion amongst the investor community. And I wanted to ask what it was and also suggest that you start putting it in your MD&A so that everybody knows.

[Christopher A. Newman, Chief Financial Officer]

Sure. No problem. Thank you, Mike. We will definitely consider publishing that. It's $29.80. So -- and feel free to e-mail me after if you want any questions on -- for the math behind that. But yes, that's it, and we'll think about publishing that number.

[Unknown Shareholder]

What you -- yes, if you could put it in the MD&A, that would be great, along with the math of how you arrive at that number because I see 5 different numbers and different sources. And I think that there'll be quite a reaction from a lot of different people who are confused about it. So yes.

[Operator]

[Operator Instructions] And your next question will be from Dean Wilkinson at CIBC.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

John, how much can you push rent down in the U.S. on renewal before you start to get some pushback yourself?

[John Talano, Vice President of Operations]

It absolutely depends on the market. We -- through our revenue management software, in general, we're going between 8% and 10% right now, and we're not seeing a whole lot of pushback.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

All right. And then if you've got a 34% differential to pre-pandemic markets, that would suggest there's 3 to 4 years of runway on those kind of renewal rates then, correct?

[John Talano, Vice President of Operations]

Yes. Yes, correct. We're again, we're getting it while we can to absorb some of the additional expenses that we're dealing with. And it's pretty consistent with our peers. So we're all in the same boat.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Perfect. Words to live by, get it while you can. I think Rai told me that once. That's it for me.

[Operator]

And at this time, we have no further questions. Please proceed.

[Christopher A. Newman, Chief Financial Officer]

Yes. Thank you, everyone, for joining the third quarter call. We'll see you next time.

[Operator]

Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.