Canadian Apartment Properties Real Estate Investment Trust

TSX:CAR.UN

Earnings Call Analysis

Strong Financial Performance and Strategic Asset Reallocation

Canadian Apartment Properties reported a robust second quarter, with high occupancies at 98.2% and a 5.4% increase in operating revenues driven by an average monthly rent of $1,577. The net operating income rose by 7.2% and the margin expanded to 67%. Diluted funds from operations per unit increased by 9.2% to $0.644. The company completed $500 million in acquisitions and $200 million in dispositions. Notably, the company fully disposed its equity interest in IRES and announced the sale of its MHC portfolio for $740 million, reallocating capital towards core apartments. An increase in annual distributions to $1.50 per unit was also announced.

Sustained Performance and Growth

Canadian Apartment Properties Real Estate Investment Trust (CAPREIT) demonstrated robust performance in Q2 2024. The occupancy rate stood at 98.2%, and the average rent was $1,577 per month, leading to a 5.4% increase in operating revenues year-over-year. Solid cost control measures boosted the Net Operating Income (NOI) by 7.2%, with the NOI margin expanding by 110 basis points to 67%. The company's diluted Funds From Operations (FFO) per unit rose by 9.2% to $0.644.

Strategic Transactions and Portfolio Optimization

CAPREIT has been active in optimizing its portfolio through strategic acquisitions and dispositions amounting to nearly $500 million since Q1. This includes increasing the share of newly-built properties in Canada to 13%. Notably, CAPREIT disposed of its remaining equity in IRES and announced the sale of its MHC portfolio for $740 million, redirecting capital towards core apartment assets where it has the strongest competitive advantage.

Acquisition Focus and Market Strategy

In 2024, CAPREIT acquired recently constructed apartment properties worth over $500 million, which is a record for the company since focusing on new builds. These acquisitions have substantially increased the quality of their portfolio, especially considering they were made at favorable cap rates. Conversely, CAPREIT achieved nearly $200 million in off-strategy dispositions, often selling older and regulated properties to nonprofit organizations to help alleviate the housing crisis.

Debt and Capital Management

CAPREIT has maintained a stable debt profile with a total debt to gross book value ratio of 41.5% and consistent debt service and interest coverage ratios of 1.8x and 3.3x respectively. The company also conserved capital through strategic reallocation, reducing common area expenditures by 29% while increasing essential repairs and maintenance to preserve revenue growth and enhance cash returns.

Environment, Social, Governance (ESG) Initiatives

CAPREIT continues to build on its ESG commitments, investing $30.7 million in energy-saving and water efficiency projects, marking a 50% increase over the previous year. Additionally, they have remained committed to providing affordable housing, evidenced by selling properties to nonprofit entities. This underscores CAPREIT's dedication to sustainability and social responsibility.

Outlook and Future Plans

Looking ahead, CAPREIT plans to increase its annualized distribution to $1.50 per trust unit starting in August 2024. The company aims to further streamline its operations by completing the sale of its MHC portfolio by Q4 2024. They are also exploring more acquisition opportunities, especially in purpose-built rental sectors, which align with current market dynamics and offer long-term growth prospects.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning. Thank you for attending today's Canadian Apartment Properties Second Quarter 2024 Results Conference Call. My name is Cole, and I'll be the moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. [Operator Instructions]. I'd now like to pass it over to Nicole Dolan. Please go ahead.

[Nicole Dolan, executive]

Thank you, operator, and good morning, everyone. Before we begin, let me remind everyone that during our conference call this morning, we may include forward-looking statements about expected future events and the financial and operating results of CAPREIT, which are subject to certain risks and uncertainties. We direct your attention to Slide 2, and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Kenny, President and CEO.

[Mark Kenney, executive]

Thanks, Nicole, and good morning, everyone. Joining me this morning is Stephen Co, our Chief Financial Officer; and Julian Schonfeldt, our Chief Investment Officer. Let's begin with the operational results for our Canadian apartment portfolio. As shown on Slide 4, we continued our historical trajectory of strong performance. Occupancies remained high at 98.2% on June 30, 2024, across which our average rent was $1,577 per month. This was the primary driver of the 5.4% increase in operating revenues for the three months ended June 30, 2024, as compared to the prior year period, which you can see on Slide 5.



We Combined with solid cost control, our NOI was up by 7.2% and our margin expanded by 110 basis points to 67% for the second quarter. As a result of higher NOI as well as lower trust expenses, partially offset by higher interest costs, we're pleased to report that our diluted FFO per unit was up by 9.2% to $0.644 this past quarter. Results for the six months ended June 30, 2024, are summarized on Slide 6. You can again see robust operational performance for the same property portfolio with Canadian residential occupancy at 98.3% and AMR growth at 6.5%. Our six-month margin for same property and total portfolio expanded by 50 and 110 basis points, respectively, while our diluted FFO per unit was up by 8.3%. This was driven by higher same property NOI alongside contribution from acquisitions and lower trust expenses. Net of nonroutine reorganization costs, partially offset by dispositions and higher interest expense.



Let's move on to Slide 7. I'm very excited about the ground we've covered on our strategy since the first quarter. Julian will shortly elaborate on our Canadian acquisition and disposition activity in detail, but at a very high level, we've completed nearly $500 million in strategic transactions since Q1. This has increased a portion of our property portfolio represented by recently built properties in Canada to 13% as of today, which is up from 11% at the prior quarter end. On top of that, in June, we were pleased to have fully disposed of our remaining equity interest in IRES, and we also announced the expected sale of our MHC portfolio for $740 million in gross proceeds. These noncore dispositions are generating a significant amount of capital that we're using to fuel our high-grading strategy. Further to that, these deals are simplifying CAPREIT business, and we're thrilled to be refocusing resources on our core apartment portfolio, where our competitive advantage are the strongest. I will now turn things over to Julian to expand on our capital allocation progress.

[Julian Schonfeldt, executive]

Thanks, Mark. On Slide 9, you can see how far we've come over the past couple of years. So far in 2024, we closed on the acquisition of over $500 million in on strategy recently constructed apartment properties in Canada, which is the most we've done in any year to date since we started exclusively targeting new builds. We've also completed nearly $200 million in off-strategy dispositions in Canada, which brings our total Canadian transaction volume in 2024 to almost $700 million. This approximates the total volume we achieved in all of 2023, and we still have significant runway left in the year.



Slide 10 showcases our Canadian apartment transaction activity since the first quarter. You can see that we completed 6 acquisitions of high-quality premium rental properties for an aggregate of $387 million. These recently constructed buildings are exceptionally well-located in growing markets with strong fundamentals across the country, and we purchased them at a weighted average cap rate, which exceeds that of our three noncore dispositions. We're also continuing to sell at prices that are at or above our previously reported IFRS fair value. And importantly, all three off-strategy properties were sold to not-for-profit organizations. We said before that we're eager to transfer more of our older regulated residences into the hands of nonprofits who can retain the affordabilities of these homes in perpetuity. We're pleased to be executing on that priority and helping with the resolution of the Canadian housing crisis in this way. We're equally excited to be improving the quality of our portfolio with these strategic transactions, and we're aiming to maintain this momentum in the quarters ahead.



Slide 11 provides an overview of our development model, which we've covered previously, but I'll take a minute to highlight our latest application. On the left, you can see that we've submitted an application for an infill development, proposing two new buildings containing a total of 635 residential suites at 1050 Mark Road in the GTA. This will provide for approximately 429,000 square feet of new residential GFA to be constructed on a vacant site that is adjacent to one of our longest owned properties, which is located within 300 meters of the future Durham Scarborough Bus Rapid Transit Station. We're also excited to have had our two Davisville applications approved, and we're looking forward to seeing more of our development pipeline progress through this program. I will now turn things over to Stephen for his financial review.

[Stephen Co, executive]

Thanks, Julian, and good morning, everyone. Referring to Slide 13. Our balance sheet remains strong in the second quarter. with capacity on our Canadian credit facilities increasing to approximately $470 million. We have $285 million in Canadian mortgage principal maturing in the second half of 2024, representing 6.3% of the Canadian mortgage balance and an overall weighted average term to maturity of 5.2 years, which is one of the longest in our multi-residential peer universe. The weighted average interest rate on our Canadian mortgage portfolio remains low at just over 3%, and we continue to conservatively fix all our interest costs to mitigate volatility risk.



Slide 14 shows our staggered maturity profile and highlight the fact that we have no more than 14% of our total Canadian mortgages coming due in any given year. Proactive management of our debt financing continues to form a key part of our overall capital reallocation program, and this has empowered us to efficiently execute on our strategy. On Slide 15, you can see that our total gross -- total debt to gross book value ratio remained relatively stable at 41.5% on June 30, 2024. We've also maintained our debt service and interest coverage ratios consistent with the previous quarter at 1.8x and 3.3x, respectively.



Finally, I want to take a minute to discuss Slide 16, which demonstrates our strategic reallocation of capital, all of certain discretionary value-add improvements and into increased repairs and maintenance without impacting revenue growth. For extra clarity, this initiative excludes energy, structural, life and safety, and other critical nondiscretionary CapEx. That said, you can see that we've been scaling back on common area and in expenditures, which are capitalized to the balance sheet. Instead, we're reallocating a portion of that spend into additional R&M work, which negatively impacts our NOI margins. However, overall, we're spending less and therefore, growing our cash return. For the current 6-month period, other property operating costs increased by 4% on a total portfolio or 8.5% on the same property basis with R&M representing the largest component of that.



During the same period, our common area and in-suite CapEx declined by 29%, evidencing the net savings achieved by the strategy without negatively impacting our top line growth. We're continuing to actively manage our capital in accordance with our operating environment, in order to enhance cash flows and ultimately, returns for our unit holders. With that, I will now turn things back over to Mark to wrap up.

[Mark Kenney, executive]

Thanks, Stephen. We're proud to have released our latest ESG report this past quarter, which highlights our many accomplishments in 2023. Some of these are displayed on Slide 18. For example, the fact that we invested $30.7 million in energy savings, resiliency and water efficiency projects in Canada in 2023, which represents an increase of nearly 50% from the $20.7 million spent in 2022. This will lead to lower utility costs for CAPREIT and increased comfort for our residents, while also reducing the environmental footprint of our legacy properties.



Affordable housing also continues to be a key focus of our ESG strategy, and we've remained committed and active in our endeavor to help with the solution to the housing crisis in Canada. As Julie mentioned earlier, we're proud to say that all three buyers of the regulated properties we sold since Q1 were nonprofit organization, we will be able to maintain the affordability of those homes for substantially less than the cost of building new. In addition, work remains ongoing with our peers through the Canadian rental housing providers for affordable housing initiative, and its website or affordable.ca, which outlines all the ways in which we're advocating for changes in government policies and program to address these important issues. We encourage all unitholders visit that website and also our own to learn more a better ESG achievements and plans for the future.



That brings me to Slide 19. Our overarching objective revolves around enhancing earnings, and we're proud of the robust financial results and strategic performance which we presented to you this morning. As a testament to that, and thank you to our valued unitholders, we are announcing an increase in our annualized rate of distribution to $1.50 per trust unit, effective for the August 2024 distribution and payable in September 2024. Moving forward, we remain focused on further optimizing and simplifying our business, especially with the upcoming sale of our MHC portfolio, which is expected to close in the fourth quarter of 2024. On that note, we're excited to continue to drive value and become an even better place to live, work and invest in the quarters ahead. I would like to thank you for your time this morning, and we would now be pleased to take your questions.

[Operator]

[Operator Instructions]. Our first question is from Fred Blondeau with Green Street.

[Fred Blondeau, analyst]

Just three quick questions for me. Just on the -- those $500 million acquisitions, I was wondering if you could provide a bit more color on the average LTB on these? And what kind of LTB should we be expecting on acquisition expected to close in the second half of 2024.

[Julian Schonfeldt, executive]

Brett, thanks for the question. Look, it really depends on the property. You'll see some of them in the disclosure, but the ones that closed -- I think if you looked in our press release, you'll actually see the mortgage that came on them, but Grafton Park had nothing -- actually has nothing -- the view had a pretty favorable one that we took in that it was in the -- I think, in the 80% LTB. But overall, we intend to manage the leverage more globally. And if an acquisition has over-levered or under-levered, we can take it in the portfolio and manage it after that. But generally, when there's favorable mortgage terms of whether it's high LTB or low LTB, we'll take them on.

[Fred Blondeau, analyst]

No, fair enough. And how do you feel about the NCIB at this stage versus acquisitions?

[Mark Kenney, executive]

Well, I think the stock is still incredibly good value. We are -- as I think we've said before, playing and balancing active, how to use our liquidity, our inbound liquidity with dispositions. And management will take a very thoughtful view to opportunities in the marketplace that we think a window may be closing in the next 12, 18 months. We're not exactly sure, obviously, but we love the real estate that we bought.



We're incredibly excited about this real estate we bought actually. The revolver remains a wonderful place to get accretive dollars to work. And just to kind of circle back, overall leverage as well. We don't mind storing some of the value in the assets that we bought. It's really a cheaper revolver in our mind for the future. So, we are in no rush to put additional leverage on those assets spread because it will be a top CMHC insured money in the quarters ahead.

[Fred Blondeau, analyst]

Perfect. And then last one for me. In terms of the new supply of rental units, especially in Ontario, I was wondering if you're starting to see an impact or some pressure on the portfolio or it remains, I guess, a bit manageable given the strength of the demand.

[Stephen Co, executive]

Well, I think 2025 is staged for record condo deliveries in the GTA. So that is a big Ontario effect. I think that we've also seen the effects of inflation creep into the wallets of young Canadians. Rents are peaking out. We're seeing evidence at the top end of the market that things are flattening. And -- so there -- just with inflation, I think in general, there's less money for people to spend, and that's bolting itself and rest payments now. So, we are seeing a flattening at the top end. And by top end, I mean, we're plus $5 and it's, I think, going to be very challenged. But the deliveries in 2026 fall to a record trough low. So, the market is for some interesting adjustments here over the next 24 months because you've got one year of a record high and followed by another year of a record low, and the years that fall appear to be even worse in terms of delivery.



So, there's a moment in time here and then the supply problem gets dramatically worse, -- so that story is kind of revealing itself across the country, Fred, and probably more so in the GTA. But the outlook is incredibly robust, but the next 12 months will be interesting. I think the CAPREIT portfolio is exceptionally well protected from that because we're not playing at that end of the market. In fact, we could become the affordable option in the GTA, but those would be my comments, completely speculative, of course.

[Operator]

Our next question is from Jonathan Kelcher with TD Cowen.

[Jonathan Kelcher, analyst]

Just keeping with the affordability being here, Mark. Like how would the rent-to-income ratio for new leases differ between some of the new build properties you guys have been buying this year versus some of your older noncore crop?

[Mark Kenney, executive]

Well, I love that question, Jonathan. Thank you very much. The upside-down world of Canadian rental is that our most affordable buildings are new construction assets because the income for the folks that are attracted to those assets are exceptionally high. And therefore, the rent-to-income ratios are exceptionally low. On the other side of the spectrum, in some of the buildings that we had sold to nonprofits, we were seeing the complete opposite where the rents are the current lowest. We're seeing income, obviously, that are attracting folks that are the lowest and therefore -- not therefore, but what we're actually seeing in the math is that the income-to-rent ratios are incredibly high.



So, the most affordable assets are tending to be our new construction assets and our least affordable buildings are the rental buildings that we are selling to nonprofits as an example. There are other examples of that to you. But this, again, is the upside-down world of Canada and a lack of understanding of -- we have an income distress problem in Canada more than we have a rent problem in Canada. And this is something that CAPREIT and our industry peers are working very hard to get the understanding across the policymakers.

[Jonathan Kelcher, analyst]

Okay. I guess, keeping on that, would it be fair to say that you guys are getting better lift on your new build properties versus the older stuff? Or how should we think about that?

[Julian Schonfeldt, executive]

Well, I think a cautionary note, like every building is different, depends on the competency of the developer. It depends on the stage of lease-up that we're getting it at. A lot of things. But what we are seeing clear evidence of is our ability in these unregulated assets to bring the entire rent roll to market, not unlike some of our other apartment peers with the benefits of new construction and geographical diversification. Really what we're doing here is diving into unregulated investment versus the regulated investment that we're seeing constraints. In places like Ontario, for example, with the 2.5% guideline. So yes, we're seeing that, but the lease renewal spreads in some of the other provinces on the legacy assets are excellent. So, it's just blending out the risk. That's all we're really doing here and delving into unregulated markets in a more serious fast pace than the company has ever known before.

[Operator]

We have a question from Mario Saric with Scotiabank.

[Mario Saric, analyst]

Mark, just maybe sticking to the last point on lease renewal spreads. They were up almost 100 basis points this quarter, so average 4% versus 3% last quarter. Is that sustainable? Or are there some kinds of one-off anomalous items in there? Or is that simply just a reflection of the portfolio transition to new construct over time?

[Mark Kenney, executive]

It's a bit of both. Why don't I let Stephen give some regional color on what we're seeing because it really is in the details of where it's happening.

[Stephen Co, executive]

Yes. So, Mario, look, a lot of our renewals that were stuck at the 2.5% really occurred in Q1. That's mainly Ontario. Q2, you can see really it came across the board, where in Quebec, we had significant renewal increases. Nova Scotia, even on the unregulated markets like Alberta. So that really pushed up the renewal rates for the second quarter versus the first quarter.

[Mario Saric, analyst]

Got it. Okay. And then my second question, just coming back to the conversation about affordability and kind of the acquisition strategy. The comment that market rents are flattening at the higher end seems to make sense. We're hearing that. At the same time, Mark, you mentioned the affordability and the new construct is actually higher than the older assets. The rent income ratios are lower. So, what do you think is kind of flattening market rents at the higher end if affordability there is actually not that?

[Mark Kenney, executive]

If you were to break it into tranches, it really does depend on what level of rent level you're at. So, I'll make it simple. The market above $5 a foot is very different than the market of four to five. The condo deliveries, for example, are having an effect. There's no question, you've got condos coming online at a time when folks have less money in their pocket, and that's probably definitely starting to -- the effect is being felt. Again, all whole COVID effect here, right? Like we had a slowdown in construction followed by a surge, and we're now seeing those deliveries followed by an interest rate shock. And we're seeing the -- like you look forward at the delivery, it is astonishingly low. So that speaks well for sort of the stabilization of those rents. But the biggest effect is definitely across the country in the plus $5 a foot range with some exceptions, obviously. But we just think it is affordability at the end of the day at the high-end, and that affordability problem starts to diminish as you move beyond the rent foot lot.

[Mario Saric, analyst]

Got it. Okay. And so just as a follow-up, if I look at Slide 10 on the call deck where you're highlighting your acquisitions and dispositions. Are you able to highlight what the average rent per square foot would be on the CIT acquisition and perhaps even with the rent-to-income ratios that you're modeling there?

[Mark Kenney, executive]

They're obviously very -- there's one in there that I'm incredibly proud of that is on the high-end. But let me get Julian to kind of give some examples of some then.

[Julian Schonfeldt, executive]

Yes. I mean, the Vancouver ones are going to be having market rents in the five, and I mean that's just the dynamic of that market. One of the Acorns, the brand-new ones that rent roll will be pretty close to market. We picked it up leased up, but it's pretty new, Pendrell was constructed in 2019. So even though those market rents are in the five, the in-places are below. And so, we're still -- the redrill still has some room to grow in there. The other one would be in the -- just I'm looking at them in the, call it, in the high-2 range per foot. The other ones that we acquired, give or take a bit. But that's just given those markets between Halifax, Ottawa and Edmonton is a little bit lower on a per foot basis.

[Mark Kenney, executive]

And the problem here is that we speak of the micro and we speak of the macro, there are two different things, obviously. Supplies that are in high-density, high condo delivery neighborhoods cannibalized competition amongst different parties. The assets that Julian just referred to are on their own. There is no competition in those neighborhoods of the vintage of the assets that we bought. So, they would be the exception to where like we're not seeing resistant. Very different, I'm going to say than the downtown core of Toronto where you have on popping up on every other block, those will be under generalized pressure because they're concentrated and there's the volume of offering.

[Julian Schonfeldt, executive]

Yes. I mean, one thing that's worth noting, too, Mario, is like I'm sure you've looked at these. But if you look at the locations of at least five of the six of those that are exceptionally well located, I mean, the types of locations that frankly are replaceable.

[Stephen Co, executive]

We honestly -- we had a little bit possibly ahead of ourselves of excitement on this, but we think that we are actually buying some of the best locations in the country. When you look at the zeroing on Google maps, you will see that these are unbelievable centralized locations for the cities in which they're located in.

[Mario Saric, analyst]

Got it. I'll make sure I'll take a closer look. And then on the rental income ratio, is it fair to say kind of those are in the low 30, like low to mid-30?

[Julian Schonfeldt, executive]

Yes. We don't store those due to privacy reasons, but it is fair to say that it would be a little bit more of an apple in tenancy where it's less sensitive.

[Mark Kenney, executive]

And the indicators that we do have is lagging receivables and just bad debt in general, and we can definitely say that we're seeing a trend of extremely low trailing receivables and ultimately add debt in the new construction assets versus the legacy assets.

[Operator]

Our next question is from Kyle Stanley with Jarden.

[Kyle Stanley, analyst]

Maybe just kind of stick in, Mark, just because you just kind of mentioned bad debt. I mean it's very small, but it looks like inducements and bad debt did creep up just a little bit this quarter. Is there anything to read into there, given maybe the softening economic climate or just kind of normal course and inducements given that you're maybe leasing up a few newer build assets?

[Mark Kenney, executive]

It's more on the inducement side. And I would say nothing no earthy there to kind of point to. Perhaps, Stephen, you can give some additional color.

[Stephen Co, executive]

Yes. I mean, what we're seeing in the inducement side, there are some inducements related to the new build. But I mean, I would say they were only temporary as we try to fill them up.

[Julian Schonfeldt, executive]

And Kyle when we're buying these -- they're completely modeled in. It's just a regular part of the lease-up of a building to put in case.

[Mark Kenney, executive]

It shows up in the statement, but part of model.

[Kyle Stanley, analyst]

Okay. No, that makes sense. Maybe just going back to your kind of commentary on Mario's question a minute ago, would you say that then maybe we're in a temporary softer patch for market rent growth, and that's driven by affordability and this uptick in supply. But as supply is delivered and absorbed kind of over the next, say, 12 to 18 months, you'd expect market rents to pick up again. I mean, we're well aware of the kind of supply-demand dynamics. So, it seems only logical that, that would be the trajectory. But just curious on your thoughts.

[Mark Kenney, executive]

I hate using this phrase. We kind of have to untap the environment and say what is actually happening here. In the GTA, I would say you can expect at the highest end of the market to see anemic rent growth because of competition, primarily. And an inflationary effect of folks just having less money in their pockets. It was very different when we had runaway wage inflation six to eight months ago. People are getting $20,000, $30,000 raises. So rent wasn't really the biggest focus in their life. That dynamic is changing. So that's that end.



On the more affordable end of the spectrum, the opportunity is fantastic. Our ability to harvest that is going to be difficult, because the bargains that people are sitting in are just too good to be true. So that end will be extremely solid. In terms of the overall environment for rents to rise, again, it's a tale of two cities on the legacy assets, absolutely, if you can get at it. And on the new build side -- there is a plateau that happens. The wonderful thing about an unregulated market is you can -- the tide lifts on all the rents and then it kind of steadies not perpetual.



So, we do think we're finding that right blend of having assets that are -- we can get at the upside fast in a changing market and then having that blend of assets that have a runway of growth, it will probably go on for decades. So, I don't know if that directly answers the question. But the general dynamic is indicating that we can see sort of a leveling off here, followed by another ramp-up, how dramatic that is, I really can't say. But when you're seeing deliveries going from 40,000 to 7,000 in 12 months, that tells you a lot.

[Kyle Stanley, analyst]

Yes. No, that's very helpful. And then just my last question, would you be able to talk about the market for development land today? I know we've talked about it over the last few quarters, but just curious if there's been any changes or signs of firming values given maybe the changing rate environment as we think about the potential timing towards monetizing the development rights at Davisville?

[Mark Kenney, executive]

Well, I'll let Julian take the question. But I don't know, at the end of the day, I think you talked to the brokers, they'll say it's a little soft there for development land. However, anybody with the right mind that capitalized should be jumping on that opportunity when you look at the deliveries in the next 24 months. The delivery spike and then there's nothing. And it doesn't take hours to build a building. We're talking seven-year cycle. So, if you actually look at the seven-year cycle, you are in -- or let's call it five, if you're really efficient, or four if you got zone land, you're looking at the perfect time to build now. Now it's a perfect time to get in the ground. But there's a lot of skepticism obviously around that because of interest rates, a lot of captive deliveries, a lot of skepticism for a lot of reasons. That's normally the environment to get serious and get into it. So, I think the prospects for land value are actually quite good. But it's a matter of the cost of capital right now is relatively high on a historic basis. So, I don't know what Julian would add to that.

[Julian Schonfeldt, executive]

No. I think Mark said it perfectly. The rates are still high and the condo market has been a bit soft. We think the long-term fundamentals are good. But having said all that, those dailies are just again, I'm using the same word, but exceptionally well located. So, while the market still remains a bit soft, as interest rates are elevated and the content market is off its -- we still think that we could generate pretty good demand just given how Mark, those locations are.

[Operator]

We have a question from Jimmy Shan with RBC.

[Jimmy Chen, analyst]

Just a follow up on the renewal rate comment. So, it sounds like mix was release for the bump. But when we look at the second half of this year, is the mix skewed more to Q1 or Q2, i.e., are we going to see 4% or 3% in the second half?

[Stephen Co, executive]

Yes. Jimmy, I think we're going to see probably more of a Q2 effect versus Q1 because majority of the renewals that occurred in Q1 were in Ontario. So, I would say if you look at it in the second half of the year, it's going to be more Q2 as being the benchmark.

[Jimmy Chen, analyst]

Okay. And then given all the acquisitions and dispositions, and I wondered if you could speak generally about sort of whether or not that's going to have any impact on the operations side of things, like integration work or whether you need to bulk up leasing staff some of these assets are maybe a little bit more leasing intensive. Maybe if you could speak to that a little bit?

[Mark Kenney, executive]

Well, one thing we pride ourselves on a cap rate is we are integration experts, we were able to go to other countries and new markets overnight and adapt quickly. There's no question that we're -- in the company is rallied around the fact that we are becoming a different type of operation, the needs and requirements of new construction are very different from the customer service side of things and the sales side of things and a whole host of what you're offering, it's dramatically different, I'll say, than the legacy assets, where it does tend to be more administrative, customer-focused, but still not as amenitized, and it's just a different business. We're in the project management repositioning business in that part of our portfolio than the customer service, rent maximizing side on new construction. So, we are working our way through that. And Stephen has done -- we've had to make some difficult choices rotary and those choices have been reflected in some of our restructuring costs, but we are working our way through it. And we do expect to be a different company. We are already becoming a very different company and very excited about that, but there will be additional change as we move into next year.

[Operator]

Our next question is from Matt Kornack with National Bank.

[Matt Kornack, analyst]

Just going to the renewal variance here. That's the legacy of the COVID rent moratorium in Ontario. But like obviously, given low turnover in that portfolio, that's going to be a seasonal issue probably for quite some time. But broadly speaking, I mean, Ontario seems to be way off to the rest of the nation in terms of allowable rent increases. Do you think that creates this incentive to invest in some of these assets going forward? I know you get on new there's no rent control, so it helps with supply, but you do need people to actively manage some of these older assets in Ontario as well.

[Mark Kenney, executive]

Well, it's not going to attract investment, if that's the question. We're very fortunate to having reaching the heavy lifting of investment has happened and our Ontario portfolio is being exceptionally good scale condition. It is very hard to say what's going to happen here. It's the most difficult decision for, I'll say, Ontario policymakers to make is to do the right thing and allow something closer to inflation to exist as a guideline. Sadly, Matt, it was just not an issue. When we were chugging along with inflation, we were unhappy when the wind government put this in place is cable, but really, we never got there because inflation was taking so low. So, what's happened is it's not really the guideline that's the problem. It's the churn that we're focused on. And we're coming up with some offerings to our residents, upgrade offerings to our residents where you can, in fact, get an above guideline increase or negotiate new rent in some instances. So, we are working on those kind of plans for the folks that do want to upgrade their suites. We're not forced to get. We're accepting request. I'm going to say people that want to do upgrades, and we may be able to work with that a little bit. There's plans in the background to deal with this. It's all.

[Matt Kornack, analyst]

Okay. No, that's fair. And then when we look at turnover, it seems to have stabilized, albeit at a very low level. But can you give us a sense as to the nature of the turnover, presumably it's geographically more outside of Ontario? And then like, can you give a sense as to the duration of leases that are turning. I don't know if you have that at your fingertips relative to kind of maybe the average duration of a lease in the portfolio?

[Mark Kenney, executive]

Yes. It's a great question. One, I want to be careful in answering because I would basically just say again, a tale of two different businesses. In the market rent buildings, we have historical turnover numbers happening. There's nothing unusual happening there. It's in the legacy assets, in particular, Ontario, where the guidelines are so low that we're seeing the caving of churn. Stephen can share some numbers that we haven't disclosed. We haven't disclosed -- that's something we'll give consideration in our disclosure on and -- but it is an important question. We understand.

[Matt Kornack, analyst]

Yes. No, fair enough. I think if we look at some of the turnover spreads that have bumped around a bit, but I don't think they're probably indicative of the mark-to-market in the portfolio at this point in some regions. And then, just last one --

[Mark Kenney, executive]

Yes, just on that, though, that is an incredibly important question because one may say, well, what was happening, CAPREIT 30% increases and it's come down to 21%. And the reality is that the churn is effectively getting even lower because it is the market rents that are turning, that are competing with the legacy rents that are slowing down even more. So, as we work through this, we've seen the effect of my goodness, the churn less the market rent churn is actually even lower. So, you can't look at churn on its own like we historically did because there's a certain factor of that churn, which are market rents in the legacy building, if that makes any sense, Matt.

[Stephen Co, executive]

Yes. Matt, I think just in terms of like the -- you see the more recent leases are the ones that are churning more than obviously the older leases. And you still see the very significant mark-to-market rent on the older leases. And now you just have a blend that's getting to that 20% uplift on our portfolio.

[Mark Kenney, executive]

But not like I would say in the past, if the mark-to-market is really the market rent because there was a steady release of units. It's being skewed I would just say that the comfort that -- this sounds like a negative conversation, but the comfort that unitholders should take is the runway of release value for CAPREIT is absolutely astonishing because it might be coming slow, but it's going to become for a long, long, long time. That's the benefit of becoming slow versus where you have a rent roll that lists with a tide in one giant chalk event, and then it's over. So that we're very, very mindful of the fact that we want our portfolio to have a mix of the marquee locations on the legacy side of the defense and new construction assets that are below replacement cost on the other side of the fence. That's really what we're trying to create here.

[Matt Kornack, analyst]

Yes. Said otherwise, I guess, in the context of an economy that's softening, those legacy assets are incredibly defensive to agree. But last one for me, Stephen. Like, I know we've seen an uptick on a year-over-year basis. I think you've said that that persist and then stabilize into the second half of the year. Is that still kind of the thought process? I know that was a great slide. I appreciate the incremental disclosure on CapEx versus R&M, but just any color as to how?

[Stephen Co, executive]

Yes, yes. I think I stand by what I said previously in the prior quarters as well. I mean, you're going to have a base effect in Q3 that likely will be -- the increase in R&M is going to be a lot lower than what you saw in Q1 and Q2 of this year.

[Mark Kenney, executive]

And again, I want -- I think a lot of pride in what the group is doing here and investors should take comfort in the fact that dollar is a dollar and which side and where it's classified should not matter even though it does have an effect on earnings, we don't care. We are very focused on the cash flow of the business, and I'm exceptionally proud of what the company has been able to do here regardless of its impact, a dollar is a dollar.

[Matt Kornack, analyst]

Yes. Now, the CapEx trend has been remarkable. Congrats on the quarter.

[Operator]

Our next question is from Sairam Srinivas with Cormark Securities.

[Sairam Srinivas, analyst]

Congrats on a good quarter. Just on the acquisitions completed so far and the potential acquisitions coming in, can you comment a bit about the vendors that are essentially sourcing these assets from and the potential sources you're looking over the next 12 months for new assets in the acquisition program?

[Julian Schonfeldt, executive]

It's a mix of -- I'll take the question. It's a mix of merchant developers to folks at their business models to build and sell. But also, we've been dealing with other kind of longer-term holders that are just seeking to raise new capital to redeploy elsewhere in their business. And so, I do think that the higher interest rate environment has caused some folks that otherwise may not have been sellers to be sellers. And we're very well capitalized, and we'll continue to work with that same mix of folks going forward. It's really been a great opportunity to acquire irreplaceable -- irreplaceable properties. We're not of the view that this will be open forever, but we still think the window is there for us to capitalize, and we'll continue to work hard to keep getting property like the ones that you've seen us transact on.

[Sairam Srinivas, analyst]

Definitely. It's a very opportunistic moment for these assets. Looking at Mark's comments on the softness broadly in the condo market, would that be something that could probably be a source of acquisition ahead? And I mean, just from a -- I mean, it's a pretty naive question, but in terms of product, is really make a lot of difference in terms of the condo product versus the path purpose-built product that you're seeing out there?

[Mark Kenney, executive]

Well, we remain optimistic always. It's hard to predict the future. The good news is we're getting great visibility in Julian's group with things that are available in the marketplace. And let's hope it feeds into our strategy. And if we can buy below replacement cost and we buy marquee locations, we're really trying to find that right mix in the portfolio. So, it's a wait and see, but it's something we've heard from several sources now that might be interesting in the future. Well, let's hold.

[Julian Schonfeldt, executive]

We are starting to see a little bit is as the condo markets struggled, particularly preconstruction sales. Some developers are pivoting from otherwise building condo buildings to building purpose-built and particularly as the HST was relieved, and you can still get some pretty decent financing from CMHC insured sources. And so, it's potential that we'll see a shift more towards purpose-built and providing us with more acquisition opportunities. But as Mark said, we'll see how this all plays out.

[Stephen Co, executive]

You can only imagine an environment where deposits like start getting cans like dropped on mass and there's buildings that are nearing completion. If we find those opportunities that were built with construction contracts at six, seven years ago that are being built below replacement costs. And again, we're here to talk.

[Operator]

We have a follow-up from Mario Saric with Scotiabank.

[Mario Saric, analyst]

Just a quick one for me. Mark, coming back to this upgrade program that you're offering to tenants, you may not be able to answer the question. We'll do it a shot. Is there a target acceptance rate that you're thinking about when offering the program in terms of what percentage of the portfolio? And then secondly, the increases in rent on the upgrades, would those funnel through your renewal rates or turnover rate on the lease website.

[Mark Kenney, executive]

Well, it's too soon to say, I guess, but what we've been surprised by is that we've been approached by a large number of tenants that are trying to get in the queue to rent apartments in a building that they already live in. And in that case, they're prepared, they want to stay. They want an upgraded unit and they'd be prepared to be a source of market for us within our own building. And that creates a cascading effect of then their unit is avail maybe somebody else in the building is looking for the same thing, and it starts to release turnover, okay? We have had a few examples of this where we said, of course, we would make our units available maybe even at a more attractive rate to our existing residents, but it's too early to say.



We've had some exciting success, but I would hate to kind of send a message here that this is something that could be more widely rolled out. It's just exciting. That's one scenario. The other scenario is we have had been an approach by residents that are wanting a new kitchen and are wanting a new bathroom. And then that's the kind of situation we have to kind of do the math and see the voluntary AGI is applicable. Very different than a AGI has forced you can actually do a voluntary AGI in Ontario as well. So that's something that is really driven by the tenant.

[Operator]

We have a question from Dean Wilkerson with CIBC.

[Dean Wilkinson, analyst]

Mark, more of a philosophical question. What do you think is the biggest gating factor for new purpose-built supply? Is it -- the development and construction costs? Is it the realizable rents? Or is it the cost of capital? Or maybe it's a combination of all three, but how would they rank in sort of the matrix of putting a shovel in the ground?

[Mark Kenney, executive]

It's different for every developer. What we -- round one was always development fees, and they become more prohibitive and that hasn't gone away. When you talk to most developers, there was a bit of a sigh of relief on the HST front, because development fees are just made properties completely not viable. And I heard Dorien Toronto it was $400,000 in before you get to the land and the shovel. So how does that create an affordable unit? So, there's that. Today, the distress we see in development is around mezz financing and guys that we're pro forming very different financing rates, and that is, I'd say, the overarching theme, I'll say, conversation that Julian is getting?

[Julian Schonfeldt, executive]

Yes. I mean, one, if you look at all the acquisitions we did, we're below replacement costs. And those -- the values that we pay tend to be IRR-driven. And when you've got IRR-driven values below replacement cost, who's going to build into that, right?

[Dean Wilkinson, analyst]

Yes. It's remarkable that you can buy yes. It's remarkable that you can buy a new asset below replacement cost someone's taken it back on it.

[Stephen Co, executive]

We're all interrupting each other. But it is the first time in Canada that we've seen this. It showed a 24 months ago. And it's never like it's -- we used to have these calls, and we used to talk about how we're below replacement cost and the value of the portfolio. Imagine we're seeing this with brand-new asset. It's like it's unbelievable. And so Julian, you had a great line that what people ask us about development and say, well, why would we be building when we can buy something for $0.80 on the dollar, with people that are already renting, no development risk, in many cases, preferential financing in strong markets. Like people tell us, Steve, well, what a brilliant strategy. And we just don't think it's that complicated.

[Dean Wilkinson, analyst]

No, I mean, it's great. I mean, you're doing what we all want to do, get younger and less regulated, but that's something. Appreciate it.

[Operator]

We have no additional questions at this time. So, I'll pass the call back to the management team for any closing remarks.

[Mark Kenney, executive]

I also want to thank everybody for your time today. If you have further questions, please do not hesitate to contact us at any time. Thank you again, and have a great day.

[Operator]

That concludes today's call. Thank you all for your participation. You may now disconnect your lines.