Canadian Apartment Properties Real Estate Investment Trust

TSX:CAR.UN

Earnings Call Transcript 2018-Q1

[Operator]

Good morning, ladies and gentlemen. Welcome to the CAPREIT First Quarter 2018 Results Conference Call. I would like to turn the meeting over to Mr. David Mills. Please go ahead, Mr. Mills.

[David George Mills]

Thank you, and good morning, everyone. Before we begin, let me remind everyone that the following discussion may include comments that constitute forward-looking statements about expected future events in the financial and operating results of CAPREIT. Our actual results may differ materially from these forward-looking statements. As such, statements are subject to certain risks and uncertainties. Discussions concerning these risk factors, the forward-looking statements and the factors and assumptions on which they are based can be found in CAPREIT's regulatory filings including our annual information form and MD&A, which can be obtained at sedar.com. I'll now turn things over to David Ehrlich, President and Chief Executive Officer.

[David Ehrlich, Former Trustee]

Thanks, David, and good morning, everyone, and thank you for joining us today. With me is our Chief Operating Officer, Mark Kenney; and our CFO, Scott Cryer. As you can see from Slide 4, 2017 was another record year for CAPREIT. All of our key performance benchmarks were up over last year, which continuing strong organic growth. NFFO increased just over 8%, driven once again by solid portfolio growth and strong same-property NOI. Importantly, our growth continues to be accretive as NFFO per unit rose 4%, despite strong leverage and the 4% increase in the weighted average number of units outstanding. Our NFFO payout ratio also remained conservative at 70.3%, strengthening once again from last year. Our record performance continues as we go from strength to strength. As you can see in the first quarter of 2018 from Slide 5. Revenues were up 8% compared to last year's first quarter, due to the positive contribution of acquisition and continued increases in average monthly rent and stable high occupancy. NOI rose a very strong 11.8% on the higher revenues, lower realty taxes and reduced utility cost as the percentage of revenues offset by higher R&M costs. NFFO rose almost 11% in the quarter, driven by the growth in revenue and our continuing strong increases in stabilized NOI, generating an accompanying strengthening in our payout ratio. The quarter also demonstrated accretive growth as NFFO per unit was up 7.9%, despite the 2.6% increase in weighted average number of units outstanding resulting from our March 2018 equity offering. I'll now turn things over to Mark to review our strong operational performance in more detail.

[Mark Kenney, CEO, President & Director]

Thanks, David. Good morning, everyone and thanks again for joining us today. Turning to Slide 7, you can see that we continue to perform very well from an operational perspective. Occupancy remained strong and stable with our average monthly rents rising in both the apartment and MHC segments of our business. Our ancillary revenues continue to grow, up 4.7% to $8.6 million in the quarter. Our NOI margin also strengthened, rising to 60.9% from 58.9% in the prior year's Q1. Slide 8 shows that our strong track record of organic growth continued in the first quarter of 2018, driven by increased average monthly rents and higher occupancies across all of our demographic sectors and asset types in our stabilized portfolio. Looking ahead, demand remains robust in the majority of our markets. We see occupancies remaining stable at these nearly full levels, and we believe our average monthly rents will continue to increase over time. Our turnover and renewal rates are doing very well in the majority of our markets, as shown on Slide 9, with solid increases in rents. Looking ahead, the rent guidelines for 2018 have been increased in Ontario and British Columbia: 1.8% in Ontario this year, up from 1.5% in 2017; and 4% in BC, up from 3.7% last year. These guideline increases bode well for continued organic growth through the balance of 2018. On suite turnovers, the average monthly rent increased by 9.6% for quarter 1 2018. For the last 20 years, we have demonstrated a consistent ability to generate what we believe is industry-leading organic growth, driven by high stable occupancies, increasing revenues, managing our costs and with enhanced operating efficiencies resulting from our size and scale. As you can see on Slide 10, our track record of organic growth continued in the quarter with same-property NOI rising a very strong 7%. We're confident that we can continue to deliver stable and steady growth in same-property NOI going forward. We continue to be pleased with our performance in Dublin as detailed on Slide 11. Since IRES IPO 4 years ago, we have received a total of asset and property management fees of $15.9 million. For the first quarter of 2018, this strong contribution continued with fees totaling $1.6 million, up 14% from last year's first quarter. We expect this steady and stable stream of recurring income to continue to grow as IRES builds its presence in the vibrant Dublin market. Our 15.7% retained interest in IRES also continues to generate a solid stream of dividend income, amounting to $13.3 million to date since the IRES IPO in April 2014. Our new portfolio in the Netherlands also continues to perform well, as shown on Slide 12. We have grown our presence in this strong market to 2,088 suites and we continue to evaluate further expansion opportunities in the country. Similar to Dublin, we are exporting our proven property management and marketing programs to these new properties. And in 2017, we generated $9.3 million in NOI from the portfolio with a solid $5.2 million in NOI during the first quarter of 2018. Late in 2017, we opened our own property management office in the country, which we are confident will lead to enhanced operating efficiencies going forward. I'll now turn things over to Scott for his financial review.

[Scott Cryer, Chief Financial Officer]

Thanks, Mark. Turning to our balance sheet, we continue to maintain a strong and flexible financial position as shown on Slide 14, with conservative leverage, strong coverage ratios and a further reduction in our interest cost. On March 15, we successfully completed a bought-deal equity offering, raising gross proceeds of $172.6 million, including the over-allotment option. Debt to GBV hit an all-time low of 41.5%, putting us in a great position for future acquisitions and development. With the proceeds of this successful offering, as of March 31, 2018, we had approximately $210 million available in borrowing capacity on our various Canadian, U.S. and euro credit facilities. It's also important to note that we have approximately $306 million of our properties not encumbered by mortgages as at March 31, 2018, providing further flexibility to fund our growth initiative and investment programs going forward. Our mortgage profile remains well balanced, as shown on Slide 15. As we approach 2019, our ability to top-up on renewal mortgages through to 2026 will provide significant liquidity to fund our acquisitions and development pipeline. Through the balance of 2018, we have approximately $115 million in mortgages maturing, with an average interest rate of 3.08%, and expect to refinance approximately $86 million in principal repayments with new mortgages. As of March 31, 2018, 97.3% of our current mortgages are CMHC insured, providing us with a large and diverse group of lenders willing to work with us at rates well below conventional financing. On the liquidity front, we remain well positioned to continue our growth programs, as shown on Slide 17. With the completion of our $172 million bought-deal equity offering in March, our liquidity position stood at approximately $210 million. I'll now turn things back to David to wrap up.

[David Ehrlich, Former Trustee]

Thanks, Scott. As you know, in 2017, we celebrated 20 years of growth and performance since CAPREIT's initial public offering in November of 1997. And as you can see on Slide 18, our portfolio growth and proven operating programs have generated over 2 decades of strong and accretive cash flows with conservative payout ratios through all economic cycles. We are highly confident that this track record will continue in the years ahead. We're also extremely confident in our opportunities for new development. We have now identified over 50 sites across Canada, primarily in BC and Ontario, all having strong development potential with a mix of intensification through infill and redevelopment. We have initiated the development approval process on 2 infill projects within the City of Toronto. Both are completed applications that are now under review by the city. These are prime locations in Toronto. Additional applications will be initiated in Ontario and BC in the coming months. We believe well in excess of 10,000 net new apartments will be advanced in the near- to mid-term. As stated previously, we believe developing these new properties will generate very strong and accretive returns for our unitholder. Furthermore, in many cases, we will also strengthen the value of the existing adjacent properties we own through shared amenities and other realized operating efficiencies.Providing the current market environment for profitable development of purpose-built rentals remain strong, as we see and most in the market believe, these investment opportunities will continue to represent exciting and accretive value for CAPREIT, and will also bring a significant number of new buildings into our portfolio. We very much look forward to keeping you apprised with greater detail in the coming quarters and on our Investor Day in June. In summary, we continue to remain very confident in our future. We've proven our ability to capitalize on continuing strong fundamentals in the apartment business through all economic cycles. We continue to maintain a strong financial position with the flexibility and resources to continue our growth and sustain our monthly distribution over the long term. Finally, for the last 20 years, we have demonstrated that our business strategy is succeeding and prospering, and we will continue to build on this going forward. Thank you for your time this morning. And we'll now be pleased to answer any questions you may have.

[Operator]

[Operator Instructions] And the first question is from Jonathan Kelcher from TD Securities.

[Jonathan Kelcher, Analyst]

First on the operations. The 9.6% lift on turnovers. Can you maybe give a little bit more color on that? I'd assume Toronto and Vancouver were the big drivers in that?

[Mark Kenney, CEO, President & Director]

Yes. There's no question that the majority of the effect is coming out of Toronto and Vancouver. But what we're really encouraged by is, it's also -- we're seeing strength in all of the markets right now. We're -- there's pretty much not a market in Canada right now that we're that fearful of and the whole portfolio is performing well.

[Jonathan Kelcher, Analyst]

Okay. If you look at the portfolio now, what would you think the delta is between in-place rents and current market rents?

[Mark Kenney, CEO, President & Director]

Yes, it's difficult to say, because as we hit these market rents, we're seeing a bit of a slowdown in turnover. So it's very difficult to say, Jonathan.

[Jonathan Kelcher, Analyst]

Okay. And then just turning to development, really, I guess from a high level here. Has the board laid out how much development that you guys would be comfortable doing at any one time on your balance sheet?

[David Ehrlich, Former Trustee]

No. We're in the process, which has been ongoing, of developing the -- or analyzing the opportunities. And then we'll roll into developing a strategy, which may be different for different sites and so forth. So that's the next step for us.

[Jonathan Kelcher, Analyst]

Okay. Do you have any minimum hurdle rates or unlevered yield targets that you'd be aiming for?

[David Ehrlich, Former Trustee]

No. It's really site-specific, Jonathan. So much goes into this. If you have a common garage, for example, that you can take advantage of on infill, that's a big advantage. If somebody can do partial condo on the site and you keep the rental, that's another proposition. Okay? Every situation is quite unique, and in fact, based on the site parameters and what's already built there in some cases or what you're infilling with.

[Jonathan Kelcher, Analyst]

Okay. And then -- and just on the 2 applications that you have in now. What would be your best guess on when you'd begin construction?

[David Ehrlich, Former Trustee]

It's a little hard to know, as you know, with the changes with the open bidding and so forth with the city, it's a little unclear how long that will take. So I wouldn't want to comment until things settle down a little bit and we see how other applications progress. They're not -- because they are not very aggressive in the sense that they kind of match what's already there in the neighborhood and so forth, so they shouldn't be controversial.

[Jonathan Kelcher, Analyst]

Okay. But do you -- would you think you're in the ground this year or is it 2019 -- more of a 2019 or 2020 timing?

[Mark Kenney, CEO, President & Director]

We're optimistic about, call it the end of 2019. And I think a conservative guess would be early 2020.

[Operator]

The next question is from Mike Markidis from Desjardins Bank.

[Michael Markidis, Real Estate Analyst]

Mark, I think last call you had alluded to -- or in 2017 you guys had higher R&M costs and that you were expecting that to normalize somewhat this year, but it seems like the verbiage still suggests that you're still seeing a higher year-over-year figure. Could you maybe just elaborate on what you saw in the quarter and how you expect that to trend over the rest of the year?

[Mark Kenney, CEO, President & Director]

Yes, I think that we had given an indication of stabilizing in R&M. We see that happening this year. You've got to remember, R&M does always remain a discretionary number to a certain extent, and we've been tailing off some of our CapEx spend and really doing more maintenance-type work. But our guidance on what we're going to give and do this year remains the same. $950 a unit is what we're targeting.

[Michael Markidis, Real Estate Analyst]

And with the amount that you incurred in 1Q, I understand it's probably -- maybe a little bit seasonal, but will that differ too much from the $950? Like is that going to continue to trend down throughout the year? Or do you think you're kind of at a level now where it will be consistent?

[Scott Cryer, Chief Financial Officer]

Yes, again I think Q1 run rate, if you annualize it, was close to $1,000. We're still planning that $950 level. I think Q1 of last year was a little bit lighter. So I think just sticking to that $950 figure is probably the right move.

[Michael Markidis, Real Estate Analyst]

And about $1,000 this quarter. That's really helpful. Just the G&A for the second consecutive quarter, you guys had about $2 million of nonroutine expenses. I don't need the details, but just curious, are you expecting that to eradicate going forward? Or will we see another couple of quarters of elevated G&A?

[Scott Cryer, Chief Financial Officer]

Again, I mean, we're cautious to say non-reoccurring. Obviously, we continue to try and optimize our business and that was represented in this quarter as well. We did have a significant amount of expenses related specifically to Netherlands and setup and whatnot that all hit in Q1. So those are definitely lumpy that we won't expect going forward. So if you strip that out, it's a pretty good run rate, but the nature of our business is where -- we will have nonroutine type of lumpy G&A continuing going forward.

[Michael Markidis, Real Estate Analyst]

Okay. And then last one from me before I turn it back. Just on the investment income and how that all flows through to FFO. I know there was an accounting change. I haven't had a chance to study it necessarily, but it seems like the contribution, when you include the, I guess, it would be add-back, usually when you have a fair value change it's a deduction from FFO, was higher this quarter. Is that -- how should we think about that going forward, Scott?

[Scott Cryer, Chief Financial Officer]

Yes, so there's 2 things. One is an investment we have, an equity investment in Canada. And as a result of an IFRS change, that goes through the P&L when it didn't before. So we're just normalizing that back to how it would have been treated for 2017. So really no change from that point of view. And that income is very consistent. Then we have our Netherlands, we have a noncontrolling interest, which gets re -- what's effectively gets fair valued. So we're adding back the impact of the fair value piece. That's consistent with our IRES pickup, where we add back the fair value bump as a result of investment property. So we're really, in all instances, just eliminating that unrealized fair value gain comparable to what we do with our investment properties.

[Michael Markidis, Real Estate Analyst]

Right. And I think in prior quarters, it was kind of every other quarter that the IRES piece was getting a fair value change. So the adjustment we're seeing this quarter, is that strictly related to the Canadian investment?

[Scott Cryer, Chief Financial Officer]

To the Netherlands and to the Canadian investment income.

[Michael Markidis, Real Estate Analyst]

It is -- relates to them. Okay.

[Scott Cryer, Chief Financial Officer]

Yes. Because the Netherlands component we mark-to-market the, what we'll call the liability on that, the noncontrolling interest, every quarter.

[Michael Markidis, Real Estate Analyst]

Does that break down between the 2 in the MD&A or not? I haven't had a chance to dig through it.

[Scott Cryer, Chief Financial Officer]

Yes. It should be.

[Operator]

The next question is from Mario Saric from Scotiabank.

[Mario Saric, Analyst]

I just wanted to kind of come back to the R&M question, and maybe broadly speaking, the margins. So your margin was up pretty strong year-over-year in Q1, kind of offsetting the reduction in the same-property NOI margin in Q4. So about 160, 170 basis points. I know timing plays a role into it and whatnot, but can you maybe talk about what is driving the kind of fluctuations in the year-over-year margin changes in the past 4 quarters?

[Mark Kenney, CEO, President & Director]

As it relates specifically to R&M, again, we're making good business decisions. So if we feel that investing in maintenance is a good business decision, we'll do that. That's actually proven itself out to be the right strategy. As Scott said earlier, if you look at sort of the run rate based on how we see the spend rolling out over the year, we are comfortable with that $950 number. And we will update as we go. But again, it's always done around good business decisions and a good use of cash.

[Scott Cryer, Chief Financial Officer]

And really that top line growth has been so strong and we've been able to maintain through our energy efficiencies and kind of hedged commodity pricing on utilities, we've been able to maintain that fairly flat as well as our realty taxes. So that definitely has some movement in the margin, but we see it as positive moving forward given that top line growth and stability of everything else.

[Mario Saric, Analyst]

And I guess in the disclosure in the geographic kind of dispersion breakdown, you kind of talk about lower utility costs. But in a couple of provinces like Ontario, Quebec, I think you see as well lower wages that were referenced in terms of the year-over-year improvement in the margin or same-property NOI. So I was just wondering what would be driving the wage efficiency that you're seeing in those markets given the fairly tight labor supply markets.

[Mark Kenney, CEO, President & Director]

Yes, it's what's Scott has alluded to earlier. We're continuously seeking efficiencies in the portfolio, but we're clearly seeing that with the slowdown in turnover our staffing requirements are different. And we're clearly seeing that our CapEx investment in the buildings is paying off with lower maintenance requirements. So our crews are diminished. But that is, I do think just a reality of the maturity of the portfolio now.

[Mario Saric, Analyst]

Okay. And then I guess, maybe a broader question on the margins. As you look out your '17 margin with 61.5% or so as you look out into 2018, how should we think about the broader margin growth this year? Can you expect further margin expansion or flattish? It sounds like the margin has room to grow year-over-year, but any color on that would be great?

[Mark Kenney, CEO, President & Director]

I think what you're -- I think everyone sitting on the topics, I think you're seeing a positive trend around wages, you're seeing a positive trend around R&M, and you're seeing a positive trend around our revenues. And that's all leading to better margins. So we continue to remain optimistic that we'll find efficiencies in the portfolio and produce good results.

[Mario Saric, Analyst]

Okay. Sounds good. And then just maybe somewhat of a related question, just on CapEx. Your budget for 2018 was unchanged at just under $190 million, but the budget for building improvements came up a little bit, offset by a decline in the in-suites, which I guess makes sense given the natural strength that you're seeing in the market. I'm just curious in terms of what's driving the expected increase in the building improvement quarter-over-quarter. And then, I guess, through 2021 we saw a bit of an increase as well.

[Mark Kenney, CEO, President & Director]

Yes. We did end up with some carryover items on the building structural side towards the end of 2017. We had a lot going on. And we also wanted to plan that work for early this year. So I wouldn't read too much into that. It's primarily a carryover from 2017. On the in-suite improvements, I think the theme remains consistent. We're seeing in our strongest markets that we don't need to do the level of renovation that we were once doing. We're watching our cash carefully and how we invest that cash. And in some cases, just doing basic maintenance is far better use of cash then doing full renovations. So we're going to watch that closely, but we like the trend in in-suite spend as well.

[Scott Cryer, Chief Financial Officer]

And it's also, I mean there's going to be a lot of volatility in the suite improvement. When you budget, you don't know what units are turning over. So it makes that budgeting process extremely challenging, and you have to react to market conditions pretty on the fly. So we try and provide that guidance, but the reality is that it's very hard to budget what you're going to do in suite improvement, given you don't know what units are going to turn.

[Mark Kenney, CEO, President & Director]

We'll go over this again on the Investor Day, but many of you have seen like the detail that goes into assessing what we're going to do in an apartment when we turn over. So as Scott said, like we've got several things going in our favor. Strong markets, slowing churn rate and better technology and quicker approvals to determine the appropriate scope to do when we do apartment turnover. And we're going to continue to push that. So we're doing experiments in every market of the payback on renovation versus the payback on maintenance. And the payback on maintenance is clearly the winning strategy for now. And we've invested so heavily in the portfolio over the last 20 years, we're in a really, really good spot today to do that. This is the value we've been building for shareholders over the last 20 years.

[Mario Saric, Analyst]

Yes, that makes sense. Okay. And then my last question is from the development side. So thank you for the disclosure in terms of the potential upside. Of the 50 kind of high potential redevelopments, how many would you say roughly would require tearing down existing building versus intensifying existing excess land?

[David Ehrlich, Former Trustee]

It's a very site-by-site analysis. For example, we have situations where we have large city blocks in its entirety, with townhouses around, with a huge amount of vacant space in the middle. So on a site like that, you may go up with a tower while the townhouses are still there, or 2 towers. And then demolish those as you go. So every site is different. So it's hard to make a general comment.

[Mark Kenney, CEO, President & Director]

But I think you'll see some exciting color on that during our Investor Day tour in Vancouver.

[Mario Saric, Analyst]

Okay. And then in the 2 applications in Toronto, what would the total number of incremental units be for those 2 applications?

[Mark Kenney, CEO, President & Director]

We're in the stages of pushing for as much density as we can possibly get. But we would put it in the neighborhood of 300 to 400 suites.

[Operator]

The next question is from Brad Sturges from Industrial Alliance.

[Bradley Sturges, Equity Research Analyst]

Just following up on Mario's question just on the development opportunity, and more the, I guess the opportunity, the highlight that there are strategic options potentially to try and accelerate some of the development opportunity. Would that be through potential acquisitions of more advanced development sites or in discussions with other JV partners that have sites external to the portfolio right now? I guess, I'm just looking for a little more color on how you could...

[David Ehrlich, Former Trustee]

There could be opportunities there. We essentially sold the site to get a new property, that kind of thing. But it's primarily these 50 for sure. And our greatest opportunity is within our own portfolio.

[Mark Kenney, CEO, President & Director]

You're also going to see some, again on our Investor Day, some exciting examples of deals that we've had in the works. Our Kings Club property, for example, in Toronto has been a fantastic success. You're going to see some stuff, for those of you that come in Vancouver, but there has to be a combination of both, of working with developers and sites and some properties we're going to be announcing shortly as well as our own 50 sites. It will be a mix of both.

[Bradley Sturges, Equity Research Analyst]

Got it. And I guess more operationally, obviously, we know how strong Vancouver and Toronto are. I guess if you look at Montreal which is a little bit lower rent, a little bit lower margin, but seems to be really starting to pick up steam, I guess what are the opportunities you're seeing in that market to perhaps see a little bit better NOI growth and margin growth, particularly given, I guess, what you're seeing from a demand and supply perspective in the market right now?

[Scott Cryer, Chief Financial Officer]

Well, I think we said it earlier that Montreal is doing well for us. And the more we look internally in making our own operation efficient, we've got a great presence in Montreal. For those of you that have seen what's going on in Montreal, it's pretty clear that the city is in transition. So I think we're in a great position to take advantage of that.

[Bradley Sturges, Equity Research Analyst]

Would that be an opportunity to try and add more scale to the market or are you satisfied, I guess, at this stage at the size of your Montreal portfolio?

[Mark Kenney, CEO, President & Director]

We remain optimistic on the opportunities that remain in Montreal. There's not a lot of value-add companies like ourselves that are focused in Montreal. So we remain optimistic that deal opportunities will come our way.

[Operator]

Thank you. There are no further questions at this time. I'd like to turn the meeting back over to Mr. Ehrlich.

[David Ehrlich, Former Trustee]

Thanks again for your time and attention this morning. And if you have any further questions, please don't hesitate to contact us at any time. Thanks again, and have a great day.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time. And thank you for your participation.