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 Conference Call. [Operator Instructions] This call is being recorded on Thursday, October 26, 2023.

I would now like to turn over the call to Mr. Paul Miatello, Senior Vice President. Please go ahead.

[Paul Miatello, executive]

Thanks very much, and hello to everybody. Thanks for joining us today on the REIT's Q3 2023 Analyst and Results Call. It's Paul Miatello here, Senior Vice President. We got the entire senior management team here, so I'll just do a quick role call for everybody. We've got Rai Sahi, Chairman and Chief Executive Officer; Beverley Flynn, Senior Vice President, General Council; Angela Sahi, Senior Vice President, in charge of Canadian Operations; John Talano, Senior Vice President in Charge of U.S. Operations; Patrick Seward, Business Development; and our Chief Financial Officer, Chris Newman.

So I'll turn it over to Chris now for some initial comments, and then we'll turn it -- then we'll open up for questions after that. Mr. Chris?

[Christopher Newman, executive]

Thank you, Paul. As is customary, I'll provide comments on REIT's financial position and performance. In terms of our financial position, the REIT completed the third quarter of 2023 with total assets amounting to $4.3 billion, higher compared to $3.9 billion as of December 31, 2022, due to acquisitions completed during the first quarter and from a fair value increase on the REIT's income-producing property. The REIT finished the third quarter with approximately $20 million of cash on hand and $7.9 million advance to Morguard Corporation under its $100 million revolving credit facility, providing the REIT with a total of $107.9 million of availability under the facility.

And during the quarter, the REIT completed a refinancing of 2 U.S. residential properties at an interest rate of 5.66% for terms of 8 years, providing the lease of additional net proceeds of USD 11.5 million. And year-to-date, the REIT was active under its NCIB, purchasing over 1.2 million units at an average unit price of $16.68 per unit. The REIT IFRS net asset value per unit is [ $38.40 ], making NCIB plan and appealing use of capital.

In addition, the REIT is pleased to announce an increase in its annual cash distribution of $0.02 per unit, an increase of 2.78%. This will bring the distribution to $0.74 per unit on an annualized basis from the current level of $0.72 per unit.

REIT completed the third quarter with $1.4 billion of long-term debt obligations. As of September 30, 2023, the REIT's overall weighted average term to maturity was 5.1 years, an increase from 4.9 years at December 31, 2022, and a weighted average interest rate increased to 3.72% from 3.5% at December 31, 2022. REIT's debt to gross book value ratio was 38.7% at September 30, 2023, an increase of compared to 38% since December 31, 2022.

Current income statement, net income was $39.3 million for the third quarter compared to $81.2 million in 2022, a $42 million decrease in net income is primarily due to the following noncash items, a decrease in fair value gain on real estate properties of $84.8 million, which was partially offset by an increase in fair value gain of Class B LP units $16.7 million and a decrease in deferred income taxes of $29.3 million.

IFRS net operating income was $52.4 million for the third quarter of 2023, an increase of $7.5 million or 16.8% compared to 2022. The change in foreign exchange rate increased NOI by $2.1 million over the overall variance last year.

On a same-property proportionate basis, NOI increased by $1.7 million or 12.1%, mainly due to AMR growth and lower vacancy. NOI in the U.S. increased by USD 0.1 million or 0.3%, as AMR growth was mainly offset by higher vacancy and an increase in operating expenses. And the change in foreign exchange increase in property proportionate NOI by $0.6 million.

Interest expense increased by $1.9 million for the third quarter of 2023 compared to 2022, primarily due to an increase in interest on mortgages of $2.6 million from higher principal and interest payments on the completion of the refinancing and the net impact of acquisitions and dispositions as well a higher noncash fair value gain of $0.9 million on the convertible debenture conversion option offset the increase in mortgage interest expense.

The lease third quarter performance translated into basic FFO of $21.9 million, an increase of $0.8 million or 3.8% when compared to 2022. And on a per unit basis, FFO was $0.40 per unit for the 3 months ended September 30, 2023, an increase of $0.02 compared to $0.38 per unit in 2022. The increase in FFO per unit was due to the following on a same-property proportionate basis in local currency, an increase in NOI, partially offset by an increase in interest expense and trust expenses at a $0.01 per unit positive impact. And the change in foreign exchange rate had no impact during the quarter.

The impact of acquisitions, net of dispositions of properties had a $0.02 per unit positive impact, and a decrease in other income primarily from the decrease in interest income on the Morguard facility at a $0.02 premium negative impact.

The impact from units repurchased under the REIT's NCIB had a $0.01 per unit positive impact. The REIT's FFO payout ratio declined to 45.5% for the 3 months ended September 30, 2023, compared to 2022, a very conservative level, which allows for significant cash retention. Operationally, the lease average monthly rent in Canada increased to $1,655 at September 30, 2023, a 5.2% increase compared to 2022, reflected in the quality of our Canadian portfolio. During the third quarter, the Canadian portfolio turned over 9.1% of total suites and achieved AMR growth on suite turnover of 21.6%.

While in the U.S., same-property AMR increased by 6% compared to 2022, having an average monthly rent of USD 1,844 at the end of September 2023 as the REIT's continue its strong performance, benefiting from solid market fundamentals across many regions. The REIT's occupancy in Canada finished the third quarter of 2023 at 98.9% compared to 98.3% at September 30, 2022. Rental market conditions remain strong and stable as housing demand continues to outpace supply.

Same-property occupancy in the U.S. of 93.7% at September 30, 2023, were lower compared to 95.9% at September 30, 2022. Management expects occupancies to be stable throughout the winter months with reduced leasing activities as well as fewer sweet turnovers in the majority of its markets.

And during the 9 months ended September 30, 2023, the REIT total CapEx amounted to $24 million. That included revenue-enhancing in-suite improvements, common area, external building projects, mechanical, plumbing and electrical as well as garage renovations.

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

[Operator]

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

[Jonathan Kelcher, analyst]

First question, just on the U.S. portfolio. The same-property operating costs were pretty elevated in the quarter. How much of that would you guys call onetime in nature versus continuing? Can you maybe give us a sort of best guess on how you see cost growth going forward?

[Christopher Newman, executive]

No problem. I'm going to pass it on to John, if you can assist.

[John Talano, executive]

Sure. I would say we have a few things that were driving cost. One, of course, the inflationary items in both materials and labor. But in the quarter, we did have a much higher number of move-in and move-outs than we've had in previous years. So that kind of added fuel to that fire. And -- working through really the majority of the pandemic-related evictions...

[Technical Difficulty]

[Christopher Newman, executive]

John, do we have you there? I think we have lost you.

Operator, can we still have him?

[Operator]

Yes.

[Christopher Newman, executive]

Okay. Well, we get John back on the phone. I think John was speaking to bad debt expense and there's a lot of pandemic-related evictions and turnaround on timing of that. And that would be classified as temporary. So once we make our way through that, we don't expect that debt to be elevated too much. And John mentioned earlier about the make-ready expenses, Q3 with a higher turnover, we have elevated amount of expenses associated with turnover that aren't -- don't need the capitalization criteria.

So those are the two reasons why typically in the U.S. expensed are elevated, but there is a backdrop of higher inflation and contracts are more expensive, salaries are more expensive. So there is that element as well.

[John Talano, executive]

Sorry about that. We just lost the internet here. I'm back...

[Christopher Newman, executive]

No problem. just go ahead, John.

[John Talano, executive]

Yes. I'm not sure what you guys heard of what I was saying. I didn't even notice I got cut off right away. But I was talking about some of our bad debt expense as well, which is tied to the COVID-related evictions that we couldn't process us up until now, and that was a big piece of it as well. We have a much lower turnover in the coming months, specifically in Chicago, which is one of our larger markets. And we expect turnover costs to come down significantly.

A big portion of our expense increase was insurance. That's definitely not going away. But we are working on identifying paths forward there that can help out in future years. And then also property taxes. Our values went up. So we were hit with some property tax increases. Those were not huge. We've had some really good success with our negotiations on our property taxes as well, but that's something that affected us in the quarter.

[Jonathan Kelcher, analyst]

Okay. And if you look ahead to next year, do you think your cost growth will be sort of in line with inflation, maybe a little bit above or a little bit below, how should we think about that?

[John Talano, executive]

I'm feeling good about it now. Things were absolutely crazy in terms of labor and getting folks to come not only to work at our properties as employees, but the trades and the subcontractors. That has definitely slowed down. We have seen some slowing of construction, obviously, with interest rates, whether it's multifamily or single-family homes in most of the Southern markets.

So all of Florida, Texas, Georgia, and those prices are definitely normalizing. I would say coming down off their peaks. So I don't expect those to increase, I expect those to normalize or they're not going to come down a lot. So most of a reduction we've ever seen even on the construction side was a decrease of a max of 10%. But I don't see that growing significantly in future years. I think it's stabilizing and probably coming down a bit.

[Jonathan Kelcher, analyst]

Okay. That's helpful. And then just secondly, on the occupancy was probably a little bit lower than we expected. Is that a function of the new supply? Or have you seen a drop in demand? And are you starting to use more incentives to try and maintain or increase it going into the slower winter leasing season.

[John Talano, executive]

Yes. So Chicago, specifically, we are actively managing well, actually all of our markets, but Chicago in our northern markets, like Chicago and D.C., we're actively managing our move out to where we have very, very few in the winter months. We can't do that with our new properties, Xavier but the other ones are all at a point where we have very few move outs between now and March, and that will help us significantly.

I mentioned the evictions before that actually is giving us a dip as well. That's a onetime dip. We're finally able to move out some of the non-payers that have been chronic for the last several years that are finally being processed by the Sheriff's Department. So that is a dip that you're seeing now that will go away.

And then we have -- and this has been really related to our markets that have grown the most, the quickest. So the rents rose so aggressively in places like Tampa and New Orleans, and you're talking about 35% growth over a few years, those have normalized. But we were pushing rents really hard in those markets for a long time. And I think that has peaked. I think that those are normalizing now, and we've adjusted in those few markets.

And we've had to offer a few incentives here and there, but those are related to specific units that might sit vacant. It's not all of the units that would have incentives. But again, I think we just got ahead of ourselves and that rent growth over the last several years was awesome. And it's just -- it's catching up with us so that we've had to normalize it a bit, but we're still in great shape, and in a place where our rent growth has been excellent over the last several years.

[Operator]

Your next question comes from Jimmy Shan of RBC Capital Markets.

[Khing Shan, analyst]

So maybe just following up on the U.S. portfolio. The eviction you spoke about, which markets were those again? were they Chicago, were they -- the Sunbelt market...

[John Talano, executive]

No, they're mostly Southern markets. So Atlanta, some in Florida, Louisiana, Dallas.

[Khing Shan, analyst]

I see, okay. And that would be, if you were to irrigate that in terms of occupancy slippage in the quarter, what would that look like 100 basis points or less?

[John Talano, executive]

Yes, I would say it would be less than that. We're sitting at a good spot now. We're right at about 94% occupied and almost 96% leased. So overall, I think we're in a strong position. But again, I think part of it was related to us getting ahead of ourselves on rent in those markets that we're moving so quickly. But we've made those adjustments, and we are having activity for sure. So move-in and move-outs are absolutely stable so far.

[Khing Shan, analyst]

Okay. And then you mentioned that rents in those markets, the Sunbelt markets where rents are normalizing. Is it your expectation that the lease spreads, the new lease spreads will turn negative at some point? Some of your peers will response to annual report in the Atlantas of the world, in the Florida markets, the new lease spreads being negative and continue to be negative. Is that also your expectation?

[John Talano, executive]

Well, there's a significant gap between our in-place rents and market. So we have been very conservative compared to my peers in the U.S. in terms of pushing our rents aggressively. And when I say that at the peaks, we were talking about 8%, 10%, 12% increases, but there are [indiscernible] all at one time. So we are in a much [ better ] position than most of our peers. And we were doing that thoughtfully. Our [indiscernible] residents that we have in place. So we've approached it from a moderate level. And I believe that we will be in good shape.

Yes, we do have some rents that if someone rented at the peak that might be a little lower, but we still have a good population of folks that were moving up towards market, if that makes sense.

[Khing Shan, analyst]

Okay. And then maybe just in general, if you guys can talk about what you're seeing in the acquisition investment market, both sides of the border, if you're seeing a little bit more transaction pick up and sort of what pricing you're seeing? Or what pricing trends are you seeing there?

[Christopher Newman, executive]

Do you want to start that? Or will you hear couple of comments from Patrick. Okay, maybe we start with Patrick and follow that with John.

[Patrick Seward, executive]

John, go ahead.

[John Talano, executive]

Well, I would say, again, in those markets where rents were skyrocketing, I think you have some folks that are interested in selling, but the number of actual transactions we're seeing, especially in the South is much lower. We are seeing expectations in price come down. But with interest rates rising, I'm seeing very few transactions that are actually happening in Florida, specifically folks are getting -- well, lots of deals are [indiscernible] the premium we're looking for. So it's certainly been slower than in the past years.

[Christopher Newman, executive]

Patrick?

[Patrick Seward, executive]

Just a couple of quick comments. What we can see is a move from a yield focus to dollar per pound focus on that front. We're seeing some increased attraction to quality assets and on those fronts, in Chicago specifically, there have been two very notable luxury deals that have occurred over the past 6 months, the Zara Enterprise, the private fund that is capitalized by the owner Zara has acquired the highest luxury building in Chicago since related to their $600,000 unit deal some 6, 7 years ago. They've done a transaction in excess of 475,000 on Michigan Avenue. And one of the John's favorite companies, from Chicago [ Providence Enterprise ] has bought down [ Condo Quality ] at 430,000 unit in the core. So these numbers are actually quite solid against these dire expectations and moving interest and so forth.

What you see is people who have taken tremendous risk, moving rates and with residual equity are suffering and well recapitalization that is on our book, that will offer a little opportunity for us since we are really a stable asset entity, but we will have opportunities to move our quality up in this environment. And over to you, sir.

[Khing Shan, analyst]

[indiscernible] here in Canada.

[Angela Sahi, executive]

It's Angela. So here in Canada, there is very little activity, I would say, in terms of any kind of new residential deals for GTA. And the things that we are seeing are anywhere like Patrick said, this is kind of like a $400,000 to $500,000 a door at that point, like it about $580,000 a door to construct. So we're not really looking at a lot of opportunities here right now, to be honest. Cap rates are still pretty well. It's still at 4%, but moving up a bit, yes.

[Christopher Newman, executive]

Moving up a bit. Still tight and negative leverage.

[Patrick Seward, executive]

There are some aspects coming out in Montreal, we see a few deals just come up in Toronto the other day. So stuff that we haven't seen in the while coming up now...

[Angela Sahi, executive]

Older product.

[Operator]

Your next question comes from Dean Wilkinson from CIBC.

[Dean Wilkinson, analyst]

I guess just following on Jimmy's question there then, given that your units are trading at an implied cap rate something north of 8%, I'm assuming your preference would be continue to be active on the share buyback as opposed to really out in the market looking for real property at this point?

[Christopher Newman, executive]

Yes, it's been a good use of proceeds. Right now, we're bumping up on the annual allowance, but it's come to change in the calendar year, we can move-up that another 5% or 1.4 million units. So it's definitely something we are looking at. It just depends on our -- what kind of use of capital we want to deploy.

[Dean Wilkinson, analyst]

Right. And I guess dovetailing that into your CapEx spend, is this sort of $10 million a quarter number something that you're comfortable with? Or there might be opportunities in there for maybe some revenue-enhancing stuff. And can you just remind me what the increased spend on the garage in Canada was? Was that just a catch-up on maintenance or was something bigger there?

[Christopher Newman, executive]

Just quickly on the garage...

[Angela Sahi, executive]

We have 2 garage projects and that's actually unrepaired.

[Christopher Newman, executive]

And sorry, the CapEx is $10 million in the quarter. I think during the summer, the CapEx, it's tight with activity and spending. So the year-to-date number of about [ CAD 40 million ] where we're typically landing at this rate. So yes, Q3 will still be quite high, but Q1 and Q2 are really where we don't spend too much.

[Dean Wilkinson, analyst]

Got it. And I'm assuming it might be a little too early to have any meaningful discussions on the 2024 debt roll for the Canadian properties? And is that back half of the year, front half of the year?

[Christopher Newman, executive]

Yes, there's 5. There's 3 on July 1, and 2 in December. So there's still quite a bit of time relatively speaking. But we have these things moving along CMHC is an option for us. So we have been moving down that track. And we're just putting a little bit of time on our side and we're going to get all our ducks lined up, and we'll see what the rate environment is then as we get ahead into the spring.

[Operator]

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

[Christopher Newman, executive]

Okay. Thank you for attending the Q3 call. We hope to see you next time. Bye.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.