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Canadian Apartment Properties Real Estate Investment Trust
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Good morning, ladies and gentlemen. Welcome to the CAPREIT Second Quarter 2018 Results Conference Call. I would now like to turn the meeting over to Mr. David Mills. Please go ahead, Mr. Mills.
Thanks, Martha, 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 and 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 are forward-lookings statements and the factors and assumptions on which they are based can be found on our regulatory filings, including our annual information form and MD&A, which can be found at sedar.com. I'll now turn things over to David Ehrlich, President and Chief Executive Officer.
Thanks, David. Good morning, everyone, and thank you for joining us today. With me are our Chief Operating Officer, Mark Kenney; and our CFO, Scott Cryer. Our record results generated in 2017 continued in 2018, with Q2 demonstrating even stronger performance than the first quarter of this year. Revenues were up 8.6% compared to last year due to the positive contribution of acquisitions and exceptional increases in average monthly rent and high occupancies. NOI rose a solid 12.3% in the quarter due to higher revenues, lower utility costs and wages. NFFO rose 20.8% in the quarter, driven by the growth in revenue. The quarter also demonstrated a significant accretive growth as NFFO per unit was up 14.1%. Our record performance continues to thrive throughout the first 6 months of 2018 as demonstrated by the numbers shown on Slide 5. Revenues were up over 8% compared to last year due to the positive contribution of acquisitions, exceptional increases in average monthly rent and stable high occupancy. Same-property NOI rose a very strong 7.4% as a result of a higher revenues, lower vacancies, reduced utility cost and wages. NFFO, the main measure of our performance, rose significantly to 16% through the first 6 months of 2018, driven by the growth in revenues and our continuing strong increases in stabilized NOI, generating a strong payout ratio of 65.9%. All in all, it was an even stronger quarter for CAPREIT. And I'll now turn things over to Mark to review in more detail our continuing strong operational performance.
Thanks, David. Good morning, everyone, and thanks again for joining us today. Turning to Slide 7, we are very proud of our strong operating performance, so far, this year. In fact, the second quarter was one of the most successful in our 20-year history. This was due mainly to the solid rent increases we are achieving across the portfolio and continuing near full-term occupancies. We used a hands-on approach to our business and our centralized rent management technology continues to contribute to our ability to maximize revenues in all of our markets. As you can see, average monthly rent increased by a solid 4.5% compared to the same time last year, while our occupancy rose to 98.9%. Another factor positively impacting growth in our monthly rents this year has been the upward trend of guideline increases in our British Columbia and Ontario markets. In Ontario this year, we have a rental guideline increase of 1.8%, up from 1.5% in 2017, and in British Columbia the rental guideline increased to 4% this year from 3.7% in 2017. In addition, we continue to pursue applications in Ontario for above-guideline increases, where we have invested in major capital projects. As you can see on Slide 8, we're seeing very positive trends in rent increases on suite turnovers. For the 3 and 6 months ended June 30, 2018, we generated an impressive 10.5% and 10.1% increase in average monthly rents on turnover. These numbers supersede last year, in which 5.9% and 5.1% increases were generated. Our performance in Ontario DC was particularly strong in the second quarter. In Q2, 2018 monthly residential rents in Ontario increased by 17.8% on suite turnovers, and in British Columbia monthly rents rose by 13.8% on suite turnovers. Average monthly rent on lease renewals for the 3 and 6 months ended June 30, 2018, both increased by approximately 2.2%, up from the 1.9% increase last year. We are confident these positive trends will continue going forward. 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 capturing enhanced operating efficiencies resulting from our increasing size and scale. As you can see on Slide 9, our track record of organic growth is continuing in 2018 with same-property NOI rising a very strong 7.4% through the first 6 months of this year. For the second quarter, organic growth was an even stronger 7.7%. Going forward, we are confident we can continue to deliver stable and steady growth in same-property NOI in the years ahead. We continue to be pleased with the performance in Dublin, as detailed on Slide 10. Since the IRES IPO over 4 years ago, we have received a total of asset and property management fees of $15.9 million to the end of 2017. To date, in 2018, the contribution continued with fees totaling $3.5 million, up 21% from last year. During the second quarter, we increased our ownership of IRES from 15.7% to 18% as of June 30, 2018. The increase in our ownership position reflects our confidence that IRES performance will remain very strong going forward. Our 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. Turning to Slide 11. Our portfolio in the Netherlands also continues to perform well, while further enhancing our geographic diversification. To date, we have grown our presence in this strong market to 2,091 suites, and we continue to evaluate further expansion opportunities in the country. Last year, we opened our own property management office in the country, helping us better manage our costs and our ability to strategically renovate suites on turnover to generate higher monthly rents. Looking ahead, we continue to evaluate strategies to grow in the Netherlands. I'll now turn things over to Scott for his financial review.
Thanks, Mark. Turning to our balance sheet, we continue to maintain a strong and flexible financial position, as shown on Slide 13, with conservative leverage, strong coverage ratios and a further reduction in our interest cost. Debt to GBV hit another all-time low of 40.5%, putting us in a great position for future acquisitions and development. On March 15, we successfully completed a bought-deal equity offering, raising gross proceeds of $172.6 million, including the over-allotment option. With the proceeds of this successful offering, at June 30, 2018, we had approximately $162 million available in borrowing capacity on our various Canadian, U.S. and euro credit facilities. Our mortgage portfolio remains well balanced, as shown on Slide 14, with no more than 15% coming due in a single year. Our ability to top up on renewal mortgages through 2026 will provide significant liquidity to fund our acquisition and development pipeline. Through the balance of 2018, we will have approximately $115 million in mortgages maturing with an average interest rate of 3.34%, and we expect to refinance approximately $58 million in principal repayments with new mortgages. It's also important to note that we have approximately $315 million of our properties not encumbered by mortgages as of June 30, 2018, to provide further flexibility to fund our growth and investment programs going forward. As shown on the previous slide, our mortgage portfolio remains well balanced. As we approach 2019, our ability to top up on renewal mortgages over the next 5 years will provide significant liquidity to fund our acquisitions and development pipeline. Based on the mortgage refinancing assumptions indicated on Slide 15, we can have approximately $1.7 billion in top-up liquidity over the next 5 years to fund our capital investments, acquisitions and development programs, and that excludes the additional mortgage funding on these new properties. As at June 30, 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 below conventional financing. Again, on the liquidity front, we remain well positioned to continue our growth programs, as shown on Slide 16. With the completion of our bought-deal equity offering in March, again, our liquidity position stands at $162 million. I'll now turn things back to David to wrap up.
Thanks, Scott. Development remains a key component to our future growth strategy. Our management team has recently assessed the viability of development and validate there is potential to build well in excess of 10,000 net new apartments, much of which are by way of infill on vacant land we already own. We are finalizing a structured roadmap to guide how this development potential will be realized over the next 10 years. Together, our management team and the board will collaborate to decide how to best move forward and maximize value for unitholders. Currently, 2 zoning -- rezoning applications are in the approval process for development in the city of Toronto, which are now under review. Assuming we are able to successfully navigate the approval process, these applications would produce a combined 274 units at the well-located Davisville and Wellesley properties. In summary, we continue to remain very confident in our future. We have 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 distributions over the long term. Thank you all for your time this morning, and we would now be pleased to answer any questions you may have.
[Operator Instructions] Our first question is from Dean Wilkinson from CIBC.
Just a quick question on the margin increase that happened in the quarter and the amount of that, which was driven by reduced repairs and maintenance. Given that you've got more R&M coming on in the back half of the year, should we expect the margin to stabilize or is this something structural that's changed?
No. I think we've made referenced to our capital programs being weighted towards the end of the year. We don't see any fundamental change in our R&M spend, so I think we -- as we said last year, we've done a lot of different programs to catch up on the preventative maintenance front and we're pretty confident, going forward, R&M will stay stable.
Stable but there's a bit of a catch-up, so we could expect here?
I wouldn't expect a dramatic catch-up of any sort.
Okay. And then just turning to the acquisition of the additional IRES units, can you confirm that, that was in fact settled in cash?
Yes.
Yes. And that was done at sort of the market price as those warrants were exercised?
Yes. And in fact, the stock is trading well above that front.
Well, for sure. That's good. And then the last one from me just on -- Scott, on the slide looking at the 5-year liquidity position in the mortgage portfolio, am I reading this right, you're looking at an expected 85 basis point hike in the underlying cap rates sort of from the, call it, low, mid-4s. So your forecast would be anticipating something in the low 5s?
Yes. I mean, I think we're just trying to sensitize that based on what the general -- the economists would think was happening to interest rate and we expanded our cap rates equivalent just to be conservative, yes.
Our following question is from Mike Markidis from Desjardins.
Mark, you made reference to 17% lift that you were getting in the Ontario portfolio. Would you be able to give us a little bit more color with respect to what you saw in the GTA versus Ottawa and I guess from Waterloo in London?
Clearly, the GTA is the strongest. Although, that being said, we're seeing very strong increases in the submarkets as well. It's -- I think it's a housing supply issue that kind of finds its way through all of Ontario to be perfectly honest. GTA is clearly leading the way.
Could you give us a sense of the magnitude? Like would GTA the -- I'm throwing out numbers here, but 25% versus kind of high single digits in the others or is it pretty much similar across the board?
It's -- we haven't given specific market updates, but I can tell you it's extremely strong in the GTA, and places like Ottawa aren't far behind.
Okay. That's fair. I just noticed that your year-over-year operating expenses in BC, Alberta and Saskatchewan were down quite significantly this quarter. Is that partly a function of the -- some of the streamlining of your operating platform you did that led to some of the nonexecutive severance earlier this year?
Yes. Scott, could give you some -- are you talking about G&A?
Or a you talking about the...
No. No. The actual operating expenses for BC, Alberta and Saskatchewan went down across the board quite significantly.
Yes. We had, in the third and fourth quarter of last year, really picked up some onetime preventative maintenance items in repairs and maintenance, and have guided that we don't see that reoccurring in the near future.
Yes, and lower utilities also contributed significantly to that as well.
On the year-over-year change?
Yes.
Okay. Okay, and then the last thing I had -- there's actually 2 more here before I turn it back. Scott, there was $900,000 roughly of other income in the financing. What does that relate to?
Yes. Those were -- that is onetime, it was insurance proceeds funding that came through this quarter, so that's just a onetime item.
Okay. And then I know you guys have a lot of variability in your G&A, a lot of pressures in late last year and earlier this year with respect to opening your Netherlands office and some of that nonexecutive severance. The 2Q number that we saw, would that be indicative now of a decent run rate going forward or...
Yes. I think as a baseline, for sure, I mean the onetime items -- we call them onetime items, they end up reoccurring more frequently than we always expect. But as a baseline, I think that's a good kickoff point, for sure.
Our following question is from Jonathan Kelcher from TD Securities.
First up on the -- in your presentation, you make reference to a deep pool of acquisition opportunities in the Netherlands. Is that something you'd expect to execute on in the back half of this year?
Yes. We're confident that those opportunities will materialize this year.
But again, Jonathan, as we've said in the past that we're still working on it to find the very best way of maximizing growth in that portfolio without keeping it all on our books -- the growth.
Sorry. Without keeping it on your books did you say?
No. Without keeping all of it on our books. In other words, grow the things significantly but have a substantial portion of it on our books. But to grow it, not necessarily to put in significantly more of CAPREIT's capital. But again, that remains to be seen as we go forward.
Okay. So you would be looking for partners to invest with?
Well, again, we're looking at a number of strategies for that.
Okay. And secondly, on the 2 developments that you highlighted, just from a high level, how should we think about cost for those and return expectations?
As we get a little bit closer to the approval process, we'll provide clarity on exactly how those pro formas are looking. But our first take on both of these properties, because there's parking that we can utilize and land with virtually -- with no cost, they're quite accretive, but we will provide some further detail as we get them finalized.
Our following question is from Brad Sturges from Industrial Alliance.
Mark, with the new PC government in power here in Ontario, I guess I'm curious to know what your interaction might have been with them, so far, in terms of either rent control legislation or development. Is there any color or takeaway that you could provide at this stage?
This government appears to be very serious about addressing the supply issue and encouraging rental investment in the province, so there has been some open discussions. They're looking for feedback from our industry association, FRPO, on how to best address the supply issues. And so far, they've been quite receptive to the recommendations that have been made. We don't expect to hear from them officially with any sort of changes for the next few months, but they are actively looking for our input right now. It's encouraging.
So you're optimistic in terms of -- at least where the discussions are going at this stage?
We're certainly more optimistic than we were 3 months ago.
Right. Okay. And Scott, just in terms of the top-up potential for mortgages to enhance liquidity, is the strategy to take full advantage of that top-up potential as it comes due or is it more on an as-needed basis right now?
Generally, our approach has been to do it as it comes due. We have looked at pulling a couple mortgages forward -- or putting seconds on it. I definitely say that our debt to GBV levels are quite low. A lot of that is driven by fair value, but we still would see the use of debt as -- the way that kind of bring that leverage up a little bit. So we may look to accelerate some kind of going into late 2018 and early 2019.
The following question is from Matt Kornack from National Bank Financial.
Quickly on turnover in Ontario, so for that 17% rent increase on turnover, are you seeing trends now sub-20% on an annual basis would you think for turnover in Ontario?
Again, it's a number that we have not provided, but that is very close to the trend of the industry and there's, clearly, downward pressure on the number of units turning over that's being offset by robust increases when they actually do turn.
And are you guys -- there's been some press, and I don't think you guys have been mentioned, but having any issues with putting through AGIs at this point in the GTA.
We're fortunate that AGI process has gained a lot of attention. The bulk of our AGI applications in Ontario went through a couple of years ago. We do have active AGI applications. The attention around AGI is to be, quite frank, is around the common area improvements, lobbies, hallways, those kinds of things, where current tenants resent landlords. The perception of landlords are getting increases on turnover because of those improvements. There has been very little backlash with respect to balconies, garages, brick, the structural work, so we are taking a pretty conservative approach. Most of our common area work is done, so where we are putting applications in is for the structural-type work.
Okay. No, that makes sense. And then on property taxes, I mean we just did a quick look back at your IFRS fair values versus property tax growth and your fair values has far outreached the increase in property taxes. Do you think municipalities are going to start pushing a bit more on valuations? Or how does that process work at the end of the day from a property tax standpoint?
Scott, do you want to talk about our tax burden...
Yes. Yes, I mean, they continually push every year, definitely. It hasn't kept up with the total fair value gain. Ultimately, I guess, all property values have appreciated across those municipalities so you're only getting a percentage of the total budget lift, but we have a continuous feedback process with the municipalities. We basically challenge our property there, I think, every year through -- with the use of consultants, so we haven't seen any new pressures specifically. It's kind of fairly status quo as far as that process.
Okay. Well, that makes sense. And then on -- I just want to follow up on the OpEx side. So if I hear correctly, this quarter, it sounds like it's an okay run rate or should we look back to the second half of last year and assume that it will be somewhat similar? I know Q4 was a bit high on a number of things, so I would assume that wouldn't be replicated. But should we assume a slight increase, I guess, from the current quarter in terms of operating costs in the second half of the year?
We see our operating cost being quite stable right now.
I think, utilities is probably the only piece that's hard to call. We definitely had a win on utilities, so that could potential have some pressure as we get into the colder months but -- outside of that.
And was there -- I mean, have you seen, I guess, there was a big election issue in Ontario, but have you seen any change in utilities cost subsequent to the election? Or do you expect the lower rates in Q1 would be replicated, I guess, going forward?
I don't think we see any changes in rates. But as Scott said, we get a rise in consumption, obviously, in -- a little bit in Q3 and Q4.
Okay. And then last question on the other income, at this point, what's a good sort of stabilized recurring number there? Are we around 3.5 to -- and maybe $375,000 a quarter there -- sorry, $3.75 million?
Sorry, $3.75 million. Yes, I think that's -- yes, if you're backing out the 900 in all the fair value gains, you're kind of at pretty stable level. We've had some growth in asset management -- property management fees, but it's not that significant, so should be a good run rate.
It's typically a number that we're always pushing for more on. It's not a number that typically contracts, but it's our ability to find new sources of other income that can grow to that. But there's nothing substantial in the pipeline that should dramatically change the number, although, we'd like to see it rise.
Our following question is from Mario Saric from Scotiabank.
On -- coming back to the rent growth on Ontario, almost 18% on term. How much of that -- I think we talked about it last quarter, but it sounds like the amount of CapEx that you're putting into the buildings to get that type of rent growth is declining given the strength in the market. How should we think about the 18% growth in terms of the amount of CapEx put in this year versus last year? How much of it is pure kind of market rent driven versus return on investment?
Well, interestingly enough, we're now finding the situation in the suburbs of the GTA. I'm talking about Brampton and Scarborough, where the math is making sense again to do renovation work. Where in the GTA, I'll say in the core, there's very little differential in terms of the return that you get on that invested CapEx for in-suite, but we're seeing some very interesting opportunities deeper into the suburbs. So we are actually not materially changing, but definitely in places like Scarborough and Brampton, investing in in-suite CapEx and seeing quiet strong returns by doing that. That would outweigh what the market would naturally give us.
Got it. Okay. And then, clearly, like -- clearly, wages aren't going up at 18% in the province, and so are you starting to feel a bit of pushback in terms of affordability? And if not, is it a different tenant coming in with a different income profile that's paying the higher rent? What's affordability feeling like now?
It's a great question. I think that upscaling of the CAPREIT portfolio over the years has served us extremely well. Our bad debt levels are at all-time lows. So the trend towards default is actually falling in this rising rent environment. And I think some of you have actually heard me say before that the default rate for the CAPREIT portfolio now is actually lower than the CMHC mortgage default rate. It's really the upscaling of the portfolio that's been a very wise strategy.
Okay. Just one more question on my end. Turning to development, on the development update slide, you talked about the in excess of 10,000 net new doors on existing land. There's also a bullet there on potentially kind of focusing on redevelopment of existing buildings. I'm wondering if you can kind of highlight how you think about redevelopment of existing building versus net new apartments aside from excess land and how big that opportunity may be in terms of a percentage of your portfolio today where you think you could substantially develop a building and what types of return that...
As I said, it's really a site-by-site analysis that you have to do. Every site is different as to how to maximize that particular location. And that analysis can change sites that may have been harder to develop today, may, in 3 or 4 years, go to the top of the list, so it's not a static number. Certainly, the one where we're building on existing lands are less complicated to deal with. You're not dealing with existing tenants that have to be relocated and so forth. So the well in excess of 10,000 number is predominantly those where we have the ability to build on our land and are, therefore, much less complex. And take less time where we can, for example, as Mark mentioned, use a common garage, that's a huge cost and time savings, but I can't make a statement about all these sites because everyone's so different.
I think, Mario, to build on what David has said, is that we've actually done an incredibly intensive review of the opportunity, and that's how we've arrived at the 10,000. It's been done with a great deal of consideration. We only have, today, the 2 active applications that we've been talking about with Davisville and Wellesley. But as the applications start rolling in, we will be giving additional insights on not only how the math is going to work, but also on the opportunity. As the applications come forward, you'll get a much more clearer picture of the site-by-site opportunity that David's described.
Okay. And so when we talk about the additional opportunity for development through redevelopment of existing buildings, would that additional opportunity be already in that well in excess of 10,000 net new apartments that you referred to above?
That number is mostly made up of those opportunities. There are other opportunities where we may have to tear down something or phase a development by building something and then tearing something down. Those situations, which are a little more complicated, so these would be the first to attack subject to the fact that I reserve the right -- we reserve the right to change our minds tomorrow and find something that's so attractive that we move it up to the top of the list.
Our following question is from Neil Downey from RBC Capital Markets.
Mark, at sites like Davisville and Wellesley, is your existing parking underutilized today or when you add suites at those sites, do you simply intend to charge higher parking rents -- parking rates rather?
They are underutilized by our tenants, but leased out to third parties. So we've made the most of our opportunity. But when the buildings were originally built, typically in the 50s and 60s, you get a parking ratio to apartments of about 1.5 parking spaces per apartment. Today, in the city of Toronto, we're seeing condo applications at 0.35 parking spaces per apartment. So clearly, the market has changed, the ratio requirement has changed, but in those 2 buildings we can accommodate with a great deal of comfort the parking requirements of the new property.
We have no further questions registered at this time. I would now like to turn the meeting back over to Mr. Ehrlich.
Thank you, everyone, and have a great day.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.