Minto Apartment Real Estate Investment Trust

TSX:MI.UN

Earnings Call Transcript 2023-Q1

[Operator]

Good morning. My name is Joelle, and I will be your conference coordinator today. At this time, I would like to welcome everyone to the Minto Apartment REIT 2023 First Quarter Financial Results Conference Call. [Operator Instructions]

Before we begin, I want to remind listeners that certain statements about future events made on this conference call are forward-looking in nature. Any such information is subject to risks, uncertainties and assumptions that could cause actual results to differ materially. Please refer to the cautionary statements on forward-looking information in the REIT's news release and MD&A dated May 9, 2023, for more information. During the call, management will also reference certain non-GAAP financial measures.

Although the REIT believes these measures provide useful supplemental information about this financial performance, they're not recognized measures and do not have standardized meanings under GAAP. Please see the REIT's MD&A for additional information regarding non-GAAP financial measures, including reconciliations to the nearest GAAP measures. Thank you.

Mr. Li, you may begin your conference.

[Jonathan Li, executive]

Thank you, operator, and good morning, everyone. I'm Jonathan Li, Chief Executive Officer of Minto Apartment REIT. I'm joined by Edward Fu, our Chief Financial Officer. I will begin the call by providing an overview of our first quarter financial performance as well as other corporate developments. Edward will review our financial results and liquidity in detail, and I will discuss our property development pipeline and business outlook. Then we will be pleased to take your questions.

The first quarter represented a strong operational start to the year as robust demand in urban rental markets drove high growth in rental rates and continued strong occupancy across our portfolio. We generated double-digit growth in both same-property portfolio revenue and NOI compared to Q1 last year. Average monthly rents for the same property portfolio reached $1,755 at the end of the quarter, a year-over-year increase of 5.7%. Average occupancy in the quarter increased to 97.2% compared to 94.2% in Q1 2022 and 97.1% in Q4 2022.

We signed 343 new leases in the quarter, achieving a strong gain leaf of 16.9% over expiring rent. Market rents continue to increase in all of our markets, increasing our estimated embedded gain-to-lease potential to 15.3%. Same property portfolio NOI increased by 13.3% compared to Q1 last year, while same property NOI margin grew by 150 basis points to 59.2%. Same-property portfolio annualized suite turnover in the quarter was 13.9% compared to 20.5% in Q1 2022.

The lower turnover can be explained by a seasonal slowdown typical for Q1 and because of very tight rental market conditions, resulting in more tenants choosing to stay in place. The AFFO and AFFO per unit were both lower compared to Q1 2022 due to the impact of high interest rates on variable rate debt, which offset the growth in NOI. We are actively pursuing initiatives to reduce variable rate debt, which we will discuss shortly.

Moving to Slide 4. We repositioned 32 suites across our portfolio in Q1, generating an average annualized return of 10.3%. On March 7, we completed the sale of Hi-Level Place, a property in Edmonton for a sale price of $9.9 million and net cash proceeds of $2.9 million. This was the first property to be sold under our capital recycling strategy. Finally, on March 23, we announced amendments to the loan agreement for the Fifth and Bank property, which provide us with greater flexibility. The amendment extend our exclusive purchase option to December 31, 2023, and adjust the coupon to be equal to the all-in interest rate of the REIT's credit facility beginning July 1.

Moving to Slide 5. As I noted, we are working to reduce our variable rate debt exposure and increase our FFO and AFFO per unit and have made progress in this regard. In March, we committed to refinance $136.9 million of mortgages maturing in the next year with all-in interest rates ranging from 3.87% to 3.95%. We estimate the upward refinance potential of these maturing mortgages to be between $60 million and $70 million, which we intend to use to repay a portion of the revolving credit facility once funded.

In addition, subsequent to Q1, we made progress on the refinancing of the variable rate mortgages on our 2 most recently acquired properties, Niagara West and International. For Niagara West, we refinanced a 7.7% variable rate mortgage with a new $61.2 million 10-year CMHC insured mortgage with an annual interest rate of 3.87%. And we will imminently refinance the 7.44% variable rate mortgage at the International with a new 10-year CMHC insured mortgage at an annual interest rate that we anticipate will be approximately 4%.

The chart on this slide shows the variable rate debt made up of about 26% of total debt at the end of the first quarter with much higher rates than our fixed rate debt. After the refinancing of the 2 variable rate mortgages, this percentage will drop to approximately 16% of total debt.

I'll now invite Eddie Fu to discuss our first quarter financial and operating performance in greater detail. Eddie?

[Edward Fu, executive]

Thank you, Jon. Turning to Slide 6. Same property portfolio revenue increased by 10.5% year-over-year, reflecting higher occupancy and higher average rates. Same property portfolio NOI increased 13.3% from Q1 last year with a margin of 59.2%. The increase reflected revenue growth, which outpaced higher operating expenses, generating margin expansion. FFO per unit was $0.177, a reduction of 7%, and AFFO per unit declined 8.1% to $0.151 reflecting an average monthly rent over the last several quarters as rental market conditions have consistently strengthened.

Moving to Slide 8. As Jon noted, we generated double-digit gain on -- the average rent on new leases increased 16.9% to $2,118 per suite with gains realized across all markets. The embedded gain to lease potential at quarter end increased to 15.3%.

On Slide 9, you can see that strong rental demand is driving higher occupancy for the REIT, but turnover was relatively low in the quarter and is likely to remain below the historical average due to a tight rental market and a lack of affordable housing alternatives.

Moving to Slide 10. Operating expenses for the same property portfolio increased 6.7% compared to Q1 last year. Property operating costs increased due to higher salaries and wages from a tight labor market as well as one-time severance costs as we continue to pursue efficiency. Natural gas costs were up due to a 24% increase in overall average rates. However, the natural gas rates have fallen materially from their peak in the fall of last year. Water expenses increased over last year due to higher consumption from higher occupancy and rate increases across the portfolio.

On Slide 11, we repositioned a total of 32 suites in the first quarter, generating an ROI of 10.3% on our proportionate share. We expect to reposition 80 to 120 suites this year, a reduction from 259 last year due to lower anticipated turnover.

I will now turn it back over to Jonathan.

[Jonathan Li, executive]

Thanks, Eddie. Moving to Slide 12. I will review our development pipeline. 3 of the projects involve intensification of properties we currently own, while the other 5 are convertible development loans or CDL, with exclusive purchase options upon stabilization.

All of our developments are progressing very well with key updates provided on Slides 13 and 14. Our CDLs represent an excellent opportunity to add brand-new assets in our target growth markets. Having said that, we will continue to be disciplined and evaluate each opportunity in the context of prevailing market conditions, access to capital and cost of capital.

Now I'll turn it back over to Eddie to review our debt financing and liquidity.

[Edward Fu, executive]

Turning to Slide 15. We show a snapshot of our key debt metrics. The implementation of certain debt refinancing initiatives discussed earlier by Jon, will reduce our variable debt exposure while improving our term to maturity and our debt maturity matter going forward. We will repay $108.4 million of variable rate mortgages with the proceeds from the refinancing of the mortgages at Niagara West and the International.

On completion of these refinancings, the fixed rate portion of our total debt will increase to 84% and the CMHC insured portion will rise to 71%. In addition, we are working to further mitigate our exposure to variable rate debt from our credit facility by using proceeds from upward mortgage refinancing and other deleveraging strategies. Finally, I want to note that total liquidity was approximately $92 million at the end of March 2023 and debt to gross book value was 41.2%.

I'll now turn it back over to Jon.

[Jonathan Li, executive]

I'll conclude with our business outlook on Slide 16 before we take your questions. Canadian urban rental market conditions are currently very robust, as demonstrated by our strong gain on lease and our high occupancy in the first quarter. We expect to continue generating strong operating performance as the key fundamentals driving our sector are expected to persist. Housing affordability has been a growing prices in Canada for a decade. We expect it to remain challenging given persistent high interest rates, rising levels of immigration and the inability of new construction to keep pace with demand. Renting a home is an affordable alternative to ownership.

And in this environment, we are not surprised to see increasing numbers of Canadians opting for it and driving higher demand in our sector. We are confident that the REIT is well-positioned for long-term success with our best-in-class portfolio. We will strive for strong growth in FFO and AFFO per unit by executing on the following: one, growing NOI; two, reducing exposure to variable rate debt; three, generating capital by selling assets to fund our growth; four, continued execution of our intensification and development pipeline; and finally, prudent balance sheet and liquidity management.

We expect that executing on each element of this strategy will deliver strong returns for unitholders amid these volatile capital markets. That concludes our presentation this morning. Eddie and I would now be pleased to answer any questions you may have.

Operator, please open the line for questions.

[Operator]

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

[Jonathan Kelcher, analyst]

First, just on the -- I guess, on the 2 loans you're doing for $108 million, how would -- what are you getting in terms of loan to value on that? And how would that compare to the acquisition price a year ago?

[Edward Fu, executive]

Jon, this is Eddie here. Thanks for the question. In terms of loan to value, they're around the range around like 55% to 60%. With regards to Niagara West, as we announced, we had secured a $61.2 million mortgage, which replaces the previous 46.2%. There is a little bit of upside there on the rates on the spread between the 3.87% that we got versus 7.7% exit.

On the International, the property was coming out of the renovations and carrying higher leverage. We're going to refinance that one imminently. The -- if we're going to look at someone as a bundle, we are terming out $108 million -- and in terms of upper refinancing, it's actually pretty thin, just getting a tick over that. The real upside is the difference in spread of the rates combined, say, 7.5% for the 2 mortgages compared to just, I would say, 4% if we looked at Niagara West as well as The International. International we're estimating around 4%. That's based on CMB [indiscernible].

[Jonathan Kelcher, analyst]

Okay. Fair enough. And then secondly, you're also going to -- I guess, 2 related questions here. One, do you have a target where you want to get your variable rate debt too, I guess it goes to 16% once you get the International funded and then after that. And then the related part is that you're going to do obviously some of that with the $60 million to $70 million you expect to up finance. What's kind of the timing on that financing? Is that sort of Q2? Or does it take most of the year for you to get that money?

[Jonathan Li, executive]

We'll let Eddie answer the second question first, and then I'll handle the first question, Jonathan.

[Edward Fu, executive]

Okay. Yes. So we announced that we committed to refinance $137 million of mortgages ranging from 3.87% to 3.95%. Those are currently under review with CMHC, and we'll be looking to fund those, I would say, towards the end of Q2.

[Jonathan Kelcher, analyst]

Okay. So you think you'll get somewhere between $60 million and $70 million in up financing by the end of Q2?

[Edward Fu, executive]

That's correct.

[Jonathan Li, executive]

And then on your question about the target variable rate debt. I think our target is as low as possible. Our peers are anywhere from 0%. I think [indiscernible] down to 10% to 6%. For us, the low-hanging fruit on the refinancings, we've kind of done them already. And so really, the only other lever that we can reasonably pull our asset sales in order to pay down our variable rate debt, there's still a pretty big chunk of variable rate debt that we can pay down kind of, call it, $160 million to $180 million.

And so there's a lot of room to go still. And depending on our success on selling assets, I think you'll see virtually all of those proceeds go to paying down that variable rate debt. We don't want it to be an overhang on our numbers. We don't want it to consume some of the strong NOI growth that we expect over the near term. And therefore, it is pretty much our top priority to pay down our variable rate debt. Will I get all the way down to 0?

Probably not because, as you know, we have a lot of developments in the ground, and we have some CDL commitments that we've also committed to. So we will run a little bit on our revolver. But to the extent we can pay it down materially even from where it is after the up financing that we talked about. I think that's our goal.

[Jonathan Kelcher, analyst]

Okay. So when you're looking at asset sales, do you have a -- like what do you have in terms of unencumbered assets? And would you be targeting those first so that you can -- it could be a little bit more effective on paying down the line?

[Jonathan Li, executive]

Yes. I think when we looked at all of our assets, we looked at a bunch of different strategic reasons in order to identify the ones that we wanted to sell. Their capital structure was one of the things that we considered. And so on the properties that we have identified for sale, there is a range of capital structures on those, and there are some that are higher leverage and some that are lower leveraged.

And the liquidity in the market is going to be the #1 determining factor on whether or not to be successful to sell. Obviously, selling our lower levered ones would be great, so we can get some big equity proceeds and pay down our line. But it's going to be somewhat not fully in our control. I should mention that Paul Baron as well is here as well as John Moss, our General Counsel.

[Operator]

Your next question comes from Kyle Stanley with Desjardins.

[Kyle Stanley, analyst]

Just looking at -- we talked about turnover slowing. I'm just curious on the proportion of the units that are turning, how many of those require material CapEx to hit the leasing spreads you've been achieving? Or I guess, another way, are you having to spend a ton to hit these leasing spreads? Or how is that looking?

[Jonathan Li, executive]

Kyle, thanks for your question. No, we don't have to spend a lot of money to hit our leasing spreads. I mean these are market rents for us in terms of being able to lease it up and how we measure it. Now through the dynamic analog, we have renovated a bunch of suites that were baked into now are renting. So that lifted in some of our gain on lease numbers that you're seeing. But I'd say for the rest of them, it's a mix of nonrenovated and renovated suites, and we're able to get close to market on all of them.

[Kyle Stanley, analyst]

Okay. Perfect. And then you did mention the impact of higher water expenses. And I mean it's not a huge line item at the moment, but I'm just wondering what are you doing or could you be doing to help mitigate some of that cost inflation over time?

[Jonathan Li, executive]

Thanks, Kyle. I mean, Paul is our SVC, Operations. He spent a lot of his time trying to be more efficient from a utilities perspective. And so I'll let him talk to a couple of things we're doing on the water.

[Paul Baron, executive]

Yes. So Kyle, a number of projects that are underway as well as a few pilot projects. So one example that comes to mind is the installation of showerheads with thermostatic shutoff valves, they minimize the energy and water consumption while the shower starts up. We also have a few pilot projects that are underway, things to more easily identify leaks in toilets that are running continuously, things of that nature. So really using technology to try to minimize that cost in the long term.

[Jonathan Li, executive]

And for us, it's super important from a water perspective in particular, because, a, we're more full and b, we're finding that people are working from home 1, 2 or 3 days a week. And so the consumption of water throughout the day is a lot higher in our overall in our portfolio than it otherwise would be had we not been working even in a hybrid environment.

[Kyle Stanley, analyst]

Right. Okay. Understood there. And then just the last one. So I mean, it was good to see the purchase option on Fifth and Bank extended and I know you're working through, I think, I believe it's 4 other projects within the CDL program. Just curious to your knowledge, is MPI looking at any new projects that you might look to partner on as part of kind of the CDL program at this point?

[Jonathan Li, executive]

Yes. I mean, good question, Kyle. So the private company has access to capital. They are very active in developments, either condo or rental, the math for them is skewing much more towards rental on a lot of their projects now. They have a number of extremely exciting development in Vancouver and the Cambie Corridor as well as Kitsilano. There's 3 separate developments that they're looking at very early stages of land assemblies with partners and they're going through the doing process. We have waived on those as the REIT. I just -- we don't have the capital to lend to them today.

Having said that, they are a very good partner of ours and I think they're going to look for a way to get those to us over time should our access to capital change from what it looks like today. But super exciting stuff they're working on in Vancouver. They've got a couple of really, really large ones in Toronto as well. So again, we're super excited about the partnership. We think it works. Obviously, in today's market window doesn't really work very well. We're aware of that. We're being very disciplined. And I think you're going to see us continue to be disciplined, at least in -- so a lot in the market kind of chugs all like it's running now.

[Operator]

Your next question comes from Jimmy Shan with RBC.

[Khing Shan, analyst]

I just wanted to clarify, the $60 million to $70 million of upward refinancing. So should we expect that the full amount will be used to pay down the credit facility once you see it at the end of the quarter?

[Edward Fu, executive]

Eddie, here. Yes, that's the plan. Our intention is to use the upward refinancing to repay part of the credit facility. One that is funded.

[Khing Shan, analyst]

Okay. All right. And then I just wanted to touch on the development yield on Rich Grove and Leslie York Mills. So it looks like we have stayed about the same or even went up a tad bit. Is that really just the development charges going down that's making the big difference or was that the rents have moved up quite a bit and you've kind of trended the market was higher. Just kind of curious about the economics on the development deals today.

[Jonathan Li, executive]

Yes. Sure. So the rents have gone up relative to the pro forma. There's no doubt about that. That has offset virtually -- I'd say almost all of the schedule increases and the cost increases and the interest rate increases. Not quite fully offset, but very close. And what has taken us over the line in terms of that yield are the development charge reductions from the new build in Ontario. So that was a nice favorable move for us and has kept our yields constant consistent with the pro forma, but even improve them a little bit.

[Khing Shan, analyst]

How much have the development charges decline?

[Jonathan Li, executive]

40% to 50%.

[Operator]

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

[Matt Kornack, analyst]

Just with regards to occupancy, Toronto, Ottawa, Alberta, you're above or at 98%. Montreal is moving in the right direction but still a little bit below 94% on the same property side. Would you expect that, that's an opportunity going through the spring leasing market? Or how should we think about that at this point?

[Jonathan Li, executive]

Matt, thanks for your question. Yes, we do think that there is some occupancy upside in Montreal, pretty consistent with what we've been telling the market and expecting -- there have been -- our more expensive building as well as some of our more expensive units have been the ones that are a little bit vacant. And so our team is now working really hard. Our leasing momentum in April and the beginning of this month has been quite strong in that market. So we are cautiously optimistic about further upside in Montreal in terms of occupancy coming into the spring and summer leasing season.

[Matt Kornack, analyst]

Okay. And then with regards to turnover and kind of the propensity to turn at this point, is it fair to say that it's shifted to some extent from shorter duration leases to people staying in place longer and that the suites that are coming up now are those with more rent upside? Or any color to that effect across the portfolio would be interesting.

[Jonathan Li, executive]

Yes. Look, I actually think it's probably working the other way. So if you just think about our turnover broadly, historically, it kind of fluctuated it's quite -- it would fluctuate between the high teens to the high 20% range on an annualized basis. I think for us, going forward, come down. And so we're expecting our turnover to range between where kind of where it is today, so that 13.9%, and then it will go up to maybe low 20s.

So on average, you can see our turnover probably be in the sort of high teens on average for the -- starting to skew towards the folks who have recently moved in because the people who have been there for 3, 4, 5, 6, 7 years, very expensive for them to move. We're not seeing a sea change, but we are seeing kind of the ones who have been in place for a year or 18 months, those -- that's kind of what we're seeing.

[Matt Kornack, analyst]

Okay. That's fair commentary. And then with regards to the up-financing opportunity in 2024 and 2025, I understand like it’s a smaller amount of maturities, but would you expect that you'd continue to kind of grind away at variable rate debt with those maturities as well, getting some up financing there?

[Jonathan Li, executive]

Maybe I didn’t get into some of the detail, but I would say the more low-hanging fruit from an economic perspective for us to sell some assets and pay down the variable rate debt to the 2024 maturities in 2025. If you bring those in, you got breakage costs, it's not as ideal. One of the loans and one of the buyers that we lock is actually an early 2024 maturity. So we already are creeping into 2024 to try to bring in the ones that make sense. So absolutely, we will start looking at future maturities. Obviously, though, for us, again, I think the biggest bang for the buck will be to sell some assets and pay down some variable rate debt.

[Matt Kornack, analyst]

I should clarify, just -- I just meant adds they come to maturity in those years, so in the future. And just maybe if you could give a sense as to -- I mean, I understand that underwriting standards are a bit different from CMHC, but presumably, you've got a fair bit of potential upside to potentially up financing in the future as maturities come due.

[Edward Fu, executive]

Yes. Maturities at the time, we'll look at the underlying assets. I would think that there would be upside potential. It's just difficult to quantify what that would be today.

[Operator]

Your next question comes from Brad Sturges with Raymond James.

[Bradley Sturges, analyst]

Just a follow-up on Matt's question there. Just on the -- I guess, the existing mortgages you're refinancing and up financing, particularly as it relates to some of the loans you're pulling forward, are there -- are you expecting some prepayment pilings with that? Or are you within a window where that would be fairly minimal?

[Edward Fu, executive]

I would say that we would be in that window where it's fairly minimal. There’ll be some potentially 3 months of interest, but it's pretty nominal. As we disclosed the [ 5 ] that we have that are rate locked, we'll be looking to fund that by the end of Q2. So to answer your question, it's minimal.

[Bradley Sturges, analyst]

Okay. And then just to go back on to the variable rate exposure between the refinancing activities with the mortgages and asset sales, is it fair to say that by the end of the year, you think you'd be at the very least back in line with your peers at this point? And based on what you're looking at potentially selling, could that get you to a point where you're getting closer to the 0 than the, let's say, the 6% of debt?

[Jonathan Li, executive]

Yes, I'd say that's operational, like that would be -- we would love to be in that position because just if you think about our approach to capital structure in a market like this, I’m okay -- we're okay being very lowly levered, even way below our target when the cost of debt is so high because it gives us optionality going forward. If we want to lever it up later or if we want to use the money to buy something, it just gives us that flexibility, and we can always put more debt on the portfolio at a time when the cost of that debt is a lot cheaper than it is today.

So when our variable rate loans are costing at 6.5%, it is the most accretive thing for us to do to pay that down as quickly as possible. So you're going to see us trying to be laser focused on translating some pretty nice NOI growth into FFO and AFFO per unit growth by being smart and hopefully be able to execute in terms of paying down some of that variable rate debt.

[Bradley Sturges, analyst]

Okay. Last question for me just as you continue or start to reexplore some of the asset sales and maybe potentially put assets on the market for sale. Are there any green shoots you're seeing in the transaction market now that give you comfort that you're going to have some success in achieving fair values? Or just give some context in terms of where you're potentially selling assets and the activity levels you're seeing today?

[Jonathan Li, executive]

Yes. I think even comparing today's private transaction market to what it was even like 3 months ago, I think we're starting to see green shoots. We're seeing a little bit of activity for some of our peers, is the Internet do a very nice deal with [ Chris Point of score ]. You see CAPREIT doing some selected acquisitions. We saw Boardwalk buy something in Victoria recently. So some of the buyers that have been completely on the sidelines are coming back, access to capital and access to CMHC financing is still quite robust, even though it's slow.

So private buyers still have good access to capital. And so we're seeing more activity in the -- for the asset sales that we've launched, we're seeing a pretty good amount of the typical buyers who are at least looking, right? Like we don't know if there's a lot of [ tire takers ], we'll see if it comes to fruition. But the activity level and the folks looking are -- I think we're pleased with the process -- by the progress to date.

[Operator]

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

[Jonathan Li, executive]

Well, thank you very much, operator, and I appreciate everyone's time. And we're glad we can be really efficient and keep this to 36 minutes, which I think everyone will happy for going forward. Take care.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.