Killam Apartment REIT

TSX:KMP.UN

Earnings Call Analysis

Killam's Q2 2024 Performance Shows Strong NOI and Rental Growth Amidst New Developments

In the second quarter of 2024, Killam Apartment REIT delivered robust financial and operational results. The company achieved 8.5% same-property NOI growth and maintained an impressive apartment occupancy rate of 98.2%. Fair value gains on investment properties totaled $85.5 million, reflecting strong NOI growth. Rental rates saw a historic lift, with a 20.2% increase on turnovers. Killam's balance sheet remains strong, with debt-to-total asset ratio at 41.2%, the lowest in its history. Looking forward, the company expects NOI growth of over 8% for 2024. Significant progress in leasing new developments is expected to enhance future FFO contributions.

Strong Financial Performance Reflects Market Trends

In the second quarter of 2024, Killam Apartment REIT reported strong financial and operational results, maintaining funds from operations (FFO) per unit at $0.30, which is consistent with Q2 2023. The company achieved an impressive 8.5% same-property net operating income (NOI) growth across its portfolio, driven by robust demand for rental properties. This growth was notably higher in the apartment segment, which saw an NOI increase of 8.8%. The overall strong rental demand is evidenced by a high occupancy rate of 98.2% in same-property apartments.

Rental Rate Growth and Market Opportunities

The company reported a remarkable 20.2% average lift on turnover for apartment rentals, marking the highest rental rate growth on turnover in its history. Additionally, the renewal rate for units increased by 4.5%, demonstrating a strong trend in market rents. Overall, the weighted average increase on apartment rental rates was 8.2%, emphasizing the company's ability to capitalize on market conditions. The estimated mark-to-market spread across the portfolio sits at approximately 25%, indicating substantial growth opportunities as properties turn.

Cost Management and Elevated Margins

Killam's same-property operating margin improved by 140 basis points to 66.5%, attributed to effective cost management measures amid modest expense growth. Operating expenses increased slightly by 1.7%, with the most considerable rise seen in property taxes (up 6.6%), countered by a decrease in utility expenses (down 4%). Year-to-date, operating expenses increased just 0.4%, showcasing the company's tight control over costs during a period of inflation.

Guidance on Future Growth and Performance Metrics

For 2024, Killam has revised its NOI growth target upward from over 6% to over 8%. Year-to-date, same-property NOI is up by 9.3%. This positive outlook is supported by anticipated turnover conditions, with a forecast turnover rate of about 18% for the year, slightly below the previous year's 19%. The anticipated adjustments in performance metrics are further evidenced by expectations for a modest growth of approximately $3.2 million in earnings or $0.026 per unit in FFO from the development properties compared to 2024.

Debt Strategy and Financial Stability

Killam ended the quarter with a debt-to-total-assets ratio of 41.2%, the lowest in its operating history. To mitigate interest expense exposure, the company is increasing its coverage of CMHC-insured mortgages to 79.4%. Although higher interest expenses impacted Q2 FFO results, ongoing refinancing activities at reduced rates due to recent Bank of Canada rate cuts are expected to alleviate pressure in the coming quarters. The firm is pursuing advantageous refinancing conditions to maintain its financial stability.

Commitment to Sustainability and Future Development

Killam's focus extends beyond financial performance, with substantial progress in sustainability initiatives. The REIT aims to self-generate 10% of controlled operational electricity from renewable sources by 2025, already surpassing 5%. Recent installations of solar panels across 23 properties have contributed to significant cost savings, estimated at over $200,000 in 2023. The company is actively moving forward with various development and disposition projects, including a new 127-unit building in Golf, Ontario, and expects to exceed its $50 million target from property sales this year.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, ladies and gentlemen. Welcome to the Killam Apartment Real Estate Investment Trust Second Quarter 2024 Financial Results Conference Call. [Operator Instructions] This call is being recorded on August 8, 2024.

I would now like to turn the conference over to Mr. Philip Fraser, President and CEO. Please go ahead.

[Philip Fraser, executive]

Thank you. Good morning, and thank you for joining Killam Apartment REIT's Second Quarter 2024 Conference Call. I'm here today with Robert Richardson, Executive Vice President; Dale Noseworthy, Chief Financial Officer; and Erin Cleveland, Senior Vice President of Finance. Slides to accompany today's call are available on the Investor Relations section of our website under Events and Presentations.

I will now ask Erin to read our cautionary statement.

[Erin Cleveland, executive]

Thank you, Philip. This presentation may contain forward-looking statements with respect to Killam Apartment REIT and its operations, strategy, financial performance conditions or otherwise. The actual results and performance of Killam discussed here today could differ materially from those expressed or implied by such statements. Such statements involve numerous inherent risks and uncertainties. And although Killam management believes that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that future results, levels of activity, performance or achievements will occur as anticipated.

For further information about the inherent risks and uncertainties in respect to forward-looking statements, please refer to Killam's most recent annual information form and other securities regulatory filings found online on SEDAR. All forward-looking statements made today speak only as of the date which this presentation refers and Killam does not intend to update or revise any such statements unless otherwise required by applicable securities laws.

[Philip Fraser, executive]

Thank you, Erin. We are very pleased with our strong financial and operating results for the second quarter of 2024. Killam delivered FFO per unit of $0.30 in the quarter consistent with $0.30 per unit in Q2 2023. We achieved 8.5% same-property NOI growth across the portfolio, included 8.8% same property NOI growth in our apartment portfolio, 7.4% same-property NOI growth in our manufactured home community portfolio and 4.9 same-property NOI growth for commercial properties ended the quarter with 41.2% in debt to total asset ratio.

The lowest in our operating history, continue to focus on strengthening our balance sheet and the lease-up of our recently completed developments. We continue to see strong rental demand for our properties, which shows in our same-property apartment occupancy that ended the quarter at 98.2%. Dale will now take us through our financial results, followed by Robert, who will discuss progress made on our sustainability initiatives. I will conclude with an update on our current and recent developments and our capital allocation strategy.

I will now hand it over to Dale.

[Dale Noseworthy, executive]

Thanks, Phil. Key highlights of Killam's Q2 financial performance can be found on Slide 5. Killam achieved solid earnings growth in Q2, including fair value gains on investment properties of $85.5 million, reflecting strong NOI growth. As shown on Slide 6, our focus on capturing market rent has resulted in our highest rental rate growth on turnover in our history, achieving an impressive 20.2% average lift on turns during the second quarter. Paired with a 4.5% increase on unit renewals, our Q2 weighted average increase on apartment rental rates was 8.2% across the same property portfolio.

These strong rental increases highlight the strength of demand for apartment units across the country. Slide 7 includes our mark-to-market spread for the portfolio and by region, tolling a healthy spread of over 20% in over half of our core markets. Overall, we estimate a mark-to-market spread of approximately 25% across the portfolio, representing significant growth opportunity as units turn.

Turnover year-to-date is 10.5%, and we anticipate approximately 18% turnover for the year. Same-property apartment operating margin improved 140 basis points, ending the quarter at 66.5%. This margin improvement is attributable to our strong rental growth paired with effective cost containment. In Q2, same property operating expenses increased modestly by 1.7% as detailed on Slide 8. The most significant cost pressures in the quarter was property taxes, up 6.6%. This increase was offset by a 4% decrease in utility and fuel expenses.

Overall, for the first 6 months of the year, operating expense growth remained muted up only 0.4% across the total same property portfolio. Year-to-date, Killam's same property NOI is up 9.3%, and our 2024 NOI target remains over 8% growth for the year, up from our original target of over 6%. As Phil noted, we generated FFO per unit of $0.30 in the quarter, consistent with $0.30 per unit in Q2 2023.

Our strong NOI growth was offset by higher interest expense and vacancy in our new developments. It's standard for new developments to be dilutive during the lease-up phase as interest expense is no longer capitalized and properties carry high vacancy. Quantify the impact had these 3 properties been fully occupied during Q2, FFO per unit would have been $0.31, which would have reflected a 3.3% increase in FFO from Q2 last year. I'm pleased to report that we've made significant leasing progress on all 3 properties during the second quarter, as highlighted on Slide 10, Civic 66 and The Governor fully leased and [ Nolan II ] at 74% leased.

With these lease-up activities, these properties flipped to positive FFO contributors in July and will continue to increase their contributions to FFO as tenants move in and the remaining Nolan II unit lease up. Slide 10 outlines the expected FFO growth from these properties on a quarterly and annual basis for 2024 and 2025. Year-over-year in 2025, we expect approximately $3.2 million of earnings growth or $0.026 in FFO per unit growth from these 3 developments compared to 2024.

Higher interest expense also impacted FFO per unit growth in Q2 following higher mortgage rates on renewals during the year. With recent Bank of Canada rate cuts and the easing of bond yields, we have successfully refinanced recent mortgages at attractive rates and expect to continue to do so as we finish our 2024 mortgage maturities over the next few months.

Slide 11 includes average apartment mortgage rates by year versus prevailing CMHC insured mortgage rates. As a part of our debt management strategy, we are leveraging CMHC programs as mortgages come due with a focus on increasing our CMHC insurance coverage, which is now at 79.4% for our apartment portfolio. Increasing our coverage of CMHC insured mortgages is intended to help mitigate our interest expense exposure for the remainder of 2024 and in 2025. We are pleased to show continued strengthening of our balance sheet at a slip shown on Slide 12. At June 30, debt as a percentage of total assets was 41.2%, down 170 basis points from year-end. We continue to diligently manage our debt metrics and have reduced that to normalized EBITDA to below 10x.

I will now turn the call over to Robert, who will discuss our MHC performance and sustainability initiatives in more detail.

[Robert Richardson, executive]

Thank you, Dale, and good morning, everyone. Killam’s Seasonal Resorts delivered strong results for Q2 '24, bolstering comes manufactured home communities performance. The seasonal resorts achieved 99% occupancy at the end of Q2 and recorded 7.6% NOI growth in the second quarter of '24. Our urban and MHC portfolio also turned in impressive results, generating 7.3% net operating income growth in the second quarter of 2024. This past June, Killam released its 2023 ESG report, which aligns our commitment to incorporate sustainability practices and enhance operational performance and optimize long-term value for our stakeholders.

We have made significant progress over the past year. Highlights from our report can be seen on Slide 14, where we note Killam's progress in all 3 key ESG metrics, namely environmental, social and governance. So sustainability initiatives are integrated with our overall business strategy. Having the ability to measure and monitor our impact on the environment using leading indicators such as greenhouse gas emissions and energy consumption, enables Killam to determine areas of focus and create opportunities for operational efficiencies by investing in technologies such as tenant submetering or renewable energy production, Killam can help mitigate its exposure to rising energy costs and improved earnings.

This is the case at our property and Waterloo Westmount Place shown on Slide 15. In 2022, we installed photovoltaic solar panels covering the entire roof of the property. Through a submetering company, Killam collects revenue on solar energy produced at this property by selling this clean energy to one of our commercial tenants at the building. In 2023, we produced 450,000 kilowatt hours’ worth of energy, resulting into revenue of $56,000. This equates to a 7.5% return on investment.

Since installation, this system has produced an average of 420,000 kilowatts per year or approximately $55,000 in annual revenue. Across our total portfolio, Killam has installed solar panels at 23 properties to date. 2023, we estimate to have saved over $200,000 in energy costs for the year, which is calculated based on our actual production and the average utility rate for the respective regions. As outlined in our 2023 ESG report, we have set an ambitious long-term target for self-generating 10% of operationally controlled electricity consumed by our portfolio to renewable energy sources by 2025.

At the end of '23, we have exceeded 5% and are working to meet our 10% goal. These targets align with our mission to minimize our impact on the environment while creating value for our unitholders. We are pleased with these investments and their contributions to revenue growth and cost savings.

I will now hand you back to Philip to provide an update on our development and disposition activity.

[Philip Fraser, executive]

Thank you, Robert. During the quarter, we completed one small land acquisition with a development partner for a total combined price of $4 million. On June 17, we acquired 70% of a 2.5 acre site located at 105 Mio Road North in Golf, Ontario. We have started work on the rezoning process for a 6-story 127-unit building, which we expect the approval process to take 1 to 2 years. On May 9, we closed the sale of Woolwich apartments an 84-unit building located in Guelph for $19.2 million.

Subsequent to the quarter end, we closed the sale of [indiscernible] Bridlewood Apartments and PEI, containing 66 units for $8.4 million. We continue to see very good interest from a number of national and regional buyers for properties that are part of our disposition strategy and expect to exceed our $50 million target this year. We will have more visibility by the end of Q3. The entitlement and design process continues to advance for our 2 future developments in Calgary, the 296-unit Nolan Hill Phase II and a 235-unit building on our fourth and fifth site downtown.

Design work continues on our 128-unit Whistler development in Waterloo and the 239-unit Phase 2 at Westmouth. The Westmouth Square master plan design document for the entire site was resubmitted to the City of Waterloo earlier this year. We are now engaged with the city to determine the final scale in the form of the redevelopment. These 6 potential developments contain over 1,100 units and all are in great neighborhoods with strong local economies and strong population growth.

We are also designing the buildings to contain above average unit size and a total development cost in the $400,000 to $450,000 per unit range. This will translate into more affordable rents for all future tenants. In Halifax, we are working on an as-of-right 92-unit development at Victoria Gardens as well as of right, 150-unit development on vacant land and our [indiscernible] community.

As seen on Slide 18, the [indiscernible], our 139-unit development in Waterloo, which contains 89 1-bedroom units and 52 units is progressing on time and on budget and is expected to be completed next June. As shown on Slide 19, we started the development of [indiscernible], a story 55 unit building in Halifax in February. It's expected to be finished in Q2 2026. Is 33, 1-bedroom units and 22 2-bedroom units with an average size of 764 square feet. Include the second quarter was a strong quarter, and we are very pleased with our financial performance. I would like to thank our employees for their hard work and dedication. We will continue to execute our strategy and work to create value for all of our unitholders.

Thank you. I will now open up the call for questions.

[Operator]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]

Your first question comes from Jonathan Kelcher of TC Cowen.

[Jonathan Kelcher, analyst]

So first question, I guess we're right into the heart of the student leasing season. Have you guys noted any change in demand from international students with the change in the rules?

[Robert Richardson, executive]

Jonathan, we haven't noticed any notable change in any of our markets in terms of international students.

[Jonathan Kelcher, analyst]

And secondly, second question, just the mark-to-market, not down a lot, but it did start coming down this quarter. How much of that is a function of market rent growth slowing versus you guys just capturing the uplift? And I guess, related to that, can you maybe comment on your thoughts on market rent growth going forward?

[Erin Cleveland, executive]

I'd say it's more about capturing some over the last quarter. And over the last few quarters, we've been expanding our analytics on trying to really narrow in on that mark-to-market. So part of it is broadening our analytics work on that. So I'd say, we're not seeing market rent come down. I'd say, looking out a few months ago, we were looking at it more stabilized. I'd say recent leasing activity. We're seeing it come back up. This is a really strong period for us, and we're seeing those rents continue to grow. So I'd say, if anything, it's just us capturing and we are still seeing some upward movement in market rents.

[Jonathan Kelcher, analyst]

And is that consistent across the portfolio or some markets that have better rent growth than others?

[Erin Cleveland, executive]

Certainly, just like the slide shows our mark-to-market spread being strongest in that Kitchener Waterloo, Toronto area and Halifax. Those are the areas that we are seeing the strongest, but that's a very good picture of where we're seeing the most increase in terms of the market rents. But it would be pretty consistent over the last few quarters.

[Operator]

Your next question comes from Gaurav Mathur of Green Street.

[Gaurav Mathur, analyst]

Thank you, and good morning, everyone. Dale, as per your prepared comments, you mentioned that the turnover for the first half of the 10.5%. And for the year, you're looking to be at around the 18% mark, is here turnover rates up over the second half of the year.

[Dale Noseworthy, executive]

So that's just looking at what we historically know, what turns. So we're tracking just slightly below turnover from last year. So that's why we're expecting it to come down. We were at 19% last year. We're expecting to be around 18% this year.

[Gaurav Mathur, analyst]

And just switching gears here to the dispositions market, you've been very active, and you are on track to meet your target as well for 2024. I'm just wondering if there's been any change -- any material change in the buyer pool so far compared to the beginning of the year? Are you seeing new buyers stepping or her still mostly private buyers that are seeking asset?

[Dale Noseworthy, executive]

I think the other interesting point on that is that it's a lot of the repeat buyers. So for the folks that we sold properties to last year, they still have a strong interest to continue to look for properties that would match well with their current portfolios. So it is the -- when I said my comment of international or national and regional buyers, it's essentially well over half of them would be buyers from last year.

[Operator]

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

[Khing Shan, analyst]

So just a follow-up on your comment, Dale, about seeing a bit of an upward movement in market rent. Can you maybe give a range of kind of what sort of quantum you're seeing and sort of which markets you be referring to?

[Dale Noseworthy, executive]

Well, when I'm looking at recent activity, I'd say almost all markets over the last 6 weeks, but from a percentage perspective, I mean it's -- I'm going to say probably 2% to 5%. It's just -- it's based on recent activity.

[Khing Shan, analyst]

And is it 2% to 5% from the leases that.

[Dale Noseworthy, executive]

From probably where we were 3 months ago or I would have been... To clarify, Jimmy, that's what we're capturing on rents. So it depends a bit on what units are leasing, but I'd say, generally, cross-board we're seeing a little bit of an uptick after having seen a bit of stability over a few months prior to that.

[Khing Shan, analyst]

And then the other question I had was just on the debt expiries next year. Sort of you do have a decent amount. How are you thinking of tackling the refinancing activity there given the movement in rates and kind of where they waited to next year.

[Erin Cleveland, executive]

Yes, they're a little more evenly distributed throughout the year next year. So in terms of waiting, we're actively kind of looking at that program now and reaching out to look at some opportunities to lock in early potentially. And we'll be looking at term depending on where the rates are, but certainly liking some longer term and really pleased to see some of the rates come down. We would have seen some pricing starting to see some sub-4 from CMHC insured on those rates for 5 anyway, which we haven't seen in a while.

[Philip Fraser, executive]

But Jim, I mean, like everybody knows, if you look at it, in the last 12 months, the 5-year bond has come down almost about 100 points and the 10-year bond has come down about 50 points. So the trend is downward. We've sort of seen the peak from our point of view. You've got 2 rate cuts with sort of forecasting another 2 to 4 even by the end of this year. So everything points to our favor for 2025 in terms of what's remaining in this year, we've got a lot done in the third quarter already. So we're looking out, we're quite positive and pretty happy to see where interest rates are going.

[Operator]

Your next question comes from Matt Kornack of National Bank Financial.

[Matt Kornack, analyst]

Sorry for the minutia. But it sounds like you had some short-term vacancy in London, one property in London and then a property adjacent to a building and lease up in Calgary. Can you give us a sense as to -- is that a 1 quarter sort of variance in occupancy in those properties? Or will it take through the balance of the year?

[Robert Richardson, executive]

Well, the one in London is $180 million, and that is primarily a student high-end building, and it's about every 2 to 3 years that there's a lot of churn more than the previous years. And so we're it looks pretty good for almost being a full building versus September, and that's typically the way that, that building has performed for the last 10 years that we've owned it. And then in terms of the one building in Calgary, again, is part of the lease-up of Nolan Hill Phase II, which is across the street from [ Metro ] and also the known one. And that's basically tenants kind of moving a little bit from one of our buildings through a newer building.

[Matt Kornack, analyst]

And then I guess on CIVIC66 and Nolan Hill, can you give us a sense as to how those lease-ups are going kind of in terms of the trajectory to get to stabilized occupancy, but also where rents are coming in relative to your performance?

[Robert Richardson, executive]

Nolan Hill, I mean, basically, we said 74%, and that was as of a couple of days ago. There's continuing leasing on a weekly basis. We're averaging $1,500 for 1 bedroom, $2,000 for 2 and $2,400 for 3 still within our pro forma absolutely Civic 66. Basically, we got 1 or 2 left in a couple that have reserving at this time of the year. Our ones are 1,900 or 2s are about 2,600 and we've got a couple of cores, around $3,600, and that's within our pro forma.

[Matt Kornack, analyst]

And then the last one, just, Dale, a follow-up on, I think it was Jimmy's question with regards to the debt maturity profile. Have you been able -- or would you be inclined to given the move in the bond yields early kind of lock in a rate for anything that's maturing in the back half of this year because I know you had a fairly significant hunk of maturities in the back half.

[Dale Noseworthy, executive]

No, I'm making the assumption as we look at the potential for additional rate cuts that are going to only continue to go down.

[Operator]

[Operator Instructions] There are no further questions at this time. I would hand over the call to Philip Fraser for closing comments. Please go ahead.

[Philip Fraser, executive]

I would like to thank everyone today for listening and participating in our Q2 2024 earnings call, and we look forward to reporting our Q3 results on November 6, 2024. Thank you very much.

[Operator]

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