Morguard North American Residential Real Estate Investment Trust

TSX:MRG.UN

Earnings Call Transcript 2024-Q3

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the third quarter conference call.

[Operator Instructions]

This call is being recorded on Thursday, October 31, 2024. I would now like to turn the conference over to Paul Miatello. Please go ahead.

[Paul Miatello, executive]

Thank you, and good afternoon, everybody, and thank you for joining us for our Q3 results call. With me in the room here, I have Angela Sahi, Senior Vice President, Canadian Operations; Beverley Flynn, Senior Vice President and General Counsel. On the phone, we have John Talano, Senior Vice President, U.S. Operations. I am Paul Miatello, Senior Vice President; and we have Chris Newman, our Chief Financial Officer, and I'll turn it over to Chris now for some prepared comments.

[Christopher Newman, executive]

Great. Thank you, Paul. As is customary, I'll provide comments on the REIT's financial position and performance. In terms of our financial position, the REIT completed the third quarter of 2024 with total assets amounting to $4.4 billion higher compared to $4.1 billion as at December 31, 2023, and this was due to a fair value increase on our real estate properties, foreign exchange rate fluctuations and an increase in cash.

The REIT finished the third quarter with approximately $103.3 million of cash on hand, and $100 million available under the REIT's revolving credit facility with Morguard corporation. And the REIT completed the third quarter with $1.7 billion of long-term debt obligations.

As at September 30, 2024, the REIT's mortgage payable have an overall weighted average term to maturity of 5.1 years, an increase from 4.9 years as at December 31, 2023, and the weighted average interest rate increased to 3.87% from 3.72% at December 31, 2023. The REIT's debt to gross book value ratio was 38.9% at September 30, 2024, an increase compared to 38.7% at December 31, 2023.

During 2024, the REIT continued to be active under its NCIB, repurchasing approximately 1.1 million units at an average unit price of $16.94. The REIT's IFRS net asset value per unit is $41.30 making the NCIB plan an appealing use of capital. In addition, the REIT is pleased to announce an increase in annual cash distribution of $0.02 per unit, an increase of 2.7%. This will bring the distribution to $0.76 per unit on an annualized basis from the current level of $0.74 per unit.

Turning to the statement of income. Net loss was $18.8 million for the third quarter compared to net income of $39.2 million in 2023. The $58 million decrease in net income was primarily due to the following noncash items, an increase in fair value loss on Class B LP units of $99.7 million and an increase in deferred income taxes of $12.5 million, which was partially offset by an increase in fair value gain on real estate properties of $51.5 million.

IFRS net operating income was $52 million for the third quarter of 2024, a decrease of $0.4 million or 0.7% compared to 2023. The change in foreign exchange rate increased NOI by $0.1 million of the overall variance to last year. And on the same-property proportionate basis, NOI in Canada increased by $0.8 million or 5.3%, mainly due to AMR growth net of higher vacancy, partially offset by an increase in operating expenses. NOI in the U.S. decreased by USD 0.8 million or 4% from higher vacancy, net of AMR growth and an increase in operating expenses and the change in foreign exchange rate increased same-property proportionate NOI by $0.2 million.

Interest expense increased by $5.5 million for the third quarter of 2024 compared to 2023 primarily due to an increase in interest on mortgages of $1.7 million from higher principal and higher interest rates on the completion of the REIT's refinancing and an increase in the noncash fair value loss on the conversion -- convertible debentures conversion option of $3.5 million.

Partially offsetting the additional interest on mortgages was an increase in other income of $1.6 million, primarily from interest earned on excess cash. The REIT's third quarter performance translated into basic FFO of $21.9 million, a decrease of $0.1 million or 0.4% when compared to 2023 and on a per unit basis, FFO was $0.40 per unit for the 3 months ended September 30, 2024 compared to $0.40 per unit in 2023 as an increase in interest expense was offset by an increase in interest income, which offset on a per unit basis.

The REIT's FFO payout ratio of 45.9% for the 3 months ended September 30, 2024, compared to 45.5% in 2023 represents a very conservative level, which allows for significant cash retention. Operationally, the REIT's average monthly rent in Canada increased to $1,754 at September 30, 2024, a 6% increase compared to 2023, reflecting the quality of our Canadian portfolio. During the third quarter, the Canadian portfolio turned over 8% of total suites and achieve AMR growth on suite turnover of 24.1%. While in the U.S., AMR increased by 2% compared to 2023, having an average monthly rent of USD 1,911 at the end of the third quarter.

The REIT's occupancy in Canada finished the third quarter of 2024 at 97.8% compared to 98.9% at September 30, 2023. Rental market conditions remain strong and stable as housing demand continues to distance supply. Occupancy in the U.S. of 91.7% at September 30, 2024, was lower compared to 93.7% at September 30, 2023. The decrease in occupancy was driven by turnover in our more busy summer leasing season.

During the 9 months ended September 30, 2024, the REIT's total CapEx amounted to $31.8 million. That included revenue-enhancing in-suite and tenant improvements, garage renovations, exterior building projects, common area, energy initiative expenditures as well as mechanical plumbing and electrical projects. At this time, I'll turn the call back over to the moderator to answer some questions.

[Operator]

[Operator Instructions]

Your first question comes from Dean Wilkinson at CIBC.

[Dean Wilkinson, analyst]

Just a quick question vis-a-vis both the cash and the up-financing that you will get on those mortgages in Canada. I guess you're going to have about $160 million, how are you thinking about that? Is that going to be more geared towards the share buyback? And how do you look at that versus sort of shrinking the float or do you see opportunities at the real property side where maybe you could be back on the acquisition side of things going into 2025.

[Paul Miatello, executive]

Thanks, Dean. It's Paul here. I'll start and see if anybody has anything to add. But in terms of allocation, the NCIB will continue to be a feature for sure. We've got daily purchase restrictions, right? So we're limited to about 6,600 units per day, and then there's exemptions for a block trade per week. So we're looking, we're on the bid. So we'll continue to allocate capital to the NCIB. We still think at this point, that's probably the best use of capital just given where the stock is trading today. So we'll keep chipping away at that if nothing else.

And then on the acquisition side, yes, I mean, we're definitely knowing that the balance sheet is pretty loaded up right now. We're looking in Canada and the U.S. There is a fair bit of product available in Canada. So we've got the teams doing deep dives on the product that's for sale. And likewise, in the U.S., the transaction market is still somewhat slow, but has picked up over the last 3 or 6 months, I would say, and we're seeing more and better opportunities in the U.S. as well. And seeing stuff that's in the low -- a lot of product in the U.S. in the low 5 cap range, seeing some opportunities in around 5.5 and higher.

Those might have some more capital challenges and things like that, a little higher on the risk scale perhaps. But we're seeing a number of opportunities, but as usual, disciplined capital deployment is kind of the hallmark of a Morguard company. So we're not -- we're screening lots and taking things back for deeper conversations internally.

[Dean Wilkinson, analyst]

Right. And I'm assuming that those are like in the existing markets that you're already in or from the Canadian perspective, closer to, let's call it, home?

[Paul Miatello, executive]

Yes. I mean, well, I might characterize things a little bit differently in Canada and the U.S., I mean, we are looking at some major markets where we may not -- that may not be in footprint right now. So looking at Calgary, looking a little bit at BC and looking at some other major markets that -- or Eastern Seaport, but maybe not currently in footprint. But again and again, it's just -- we're screening a lot of stuff right now. Not to say that we're going to necessarily pull the trigger on anything out of footprint, but we're screening a lot of profit.

[Dean Wilkinson, analyst]

That makes sense. I mean if the opportunity comes up, right, you don't want to walk from something. That's all I had. I'm sure that my other colleagues will have a couple of other questions, so I will hand it back.

[Operator]

Next question comes from Jonathan Kelcher at TD Cowen.

[Jonathan Kelcher, analyst]

Paul, just to follow up on the acquisitions. I think you said low to mid-5s in the U.S. is kind of where you're looking, what about cap rates in Canada?

[Paul Miatello, executive]

Cap rates in Canada are in the usual typical range where they've been for the last year or 2, there's stuff in the high 3s. There's some stuff in the low 4s. It's kind of where we're seeing the stuff that we're screening.

[Jonathan Kelcher, analyst]

Okay. And then on the operations, I guess the year-over-year decline in the U.S. occupancy. Was that you guys trying to push rents a little bit, maybe aggressively. I noticed that it was back up post the -- occupancy was back up post this quarter.

[Christopher Newman, executive]

Yes, I'm going to turn that one over to John to assist.

[John Talano, executive]

Sure. Well, if you look at our rents, really even over the last 24 months, we've had a compound annual growth rate of 10.9% over the last 2 years. So we have been aggressive. That said, we have not been as aggressive as our peers in a lot of cases. We were very cognizant not to push out what our core rental base was especially in the southern markets like Florida.

But there are a few places that I think we have got ahead of ourselves a bit. But there's no cliff. It's more rents normalizing. And we had a lot of activity in the U.S. specifically over the last -- in Q3, the majority of our move-outs happen over those 3 months.

But it was a little more active. And yes, we were pushing rents at that time. So in a few places, we did get a little bit ahead of ourselves. Our occupancy has improved already. So we're right at about 93% and change occupied and 95% and change leased today. So we're doing well.

[Jonathan Kelcher, analyst]

And you can carry -- you think you can carry that [ through for the winter leasing season ].

[John Talano, executive]

Things have been stable, but it has been whackable a little bit with our various locations. We dipped in New Orleans, that came back. We dipped in Tampa, that came back. We dipped in Dallas, that is coming back. And then we recently dipped in one of our properties in Colorado. So we're attacking it. We're really focused on marketing and leasing. We're adjusting our rents daily. But it's been stable. Going into the winter months, definitely, things slow down. We do push the majority of our -- especially in the northern properties, we push the majority of our exposure into the summer months. So we should be good.

[Jonathan Kelcher, analyst]

Okay. And then lastly, just switching gears to Canada. Maybe give your thoughts just high level on the impact of the integration announcement last week, I guess, specifically on your portfolio and then more generally for what you think for the industry.

[Angela Sahi, executive]

This is Angela. So I can answer that. So I would say that over the last couple of years when immigration was very strong, we did have an influx of tenants. And just the momentum was there in terms of increasing rents. We were increasing rents about $50 to $100 every month. I think that's all kind of plateau now and we're still holding rents and achieving high rent growth on turnover.

However, we have to tolerate a little bit of vacancy. I think it's taking a few weeks longer than usual, we would say. And then in cases where we have some extra vacancy coming up in the pipeline, for example, when we have some external projects like parking and things like that happening. There is more turnover, which is obviously good for our rent growth, but we do not want to have too much vacancy at once. So we are offering some incentives once in a while in these cases. But typically, it hasn't had a huge impact.

I would just say that the pace of occupancy is not as strong as it was prior. The immigration is mostly -- in the Mississauga area, I would say, it's the young professionals that are coming in. We had some relationships with a few IT companies. And we were getting a handful of residents from these companies quite frequently over the last couple of years. And now that's all tapered off.

I think just because of the announcements over the last couple of months, these companies are afraid. We talk to their HR group often, and they're just afraid to bring candidates in here and being rejected eventually. So some of their people are still in the U.S. or abroad. So that's a little bit of what we're finding. Overall, there's still a big housing shortage. And so I don't think in the long term, it should be an issue.

[Operator]

[Operator Instructions]

Next question from Jimmy Shan at RBC Capital Markets.

[Khing Shan, analyst]

Just a follow-up on the U.S. occupancy. So for Dallas, in particular, the occupancy is around 88%. And if I look at the occupancy -- market occupancy in the submarket that you're in, in Dallas, it's sitting around 93%. Was there -- like what would you attribute that difference to? Is it kind of what you've referenced earlier in terms of seeing a lot of move-outs -- you pushing rents a little bit too aggressive in that market. Maybe some thoughts there.

[John Talano, executive]

Specifically in Dallas, the majority of our properties are in Las Colinas and that is high tech, and there are lots of foreign nationals that rent apartments but are also on visas. I think part of that was definitely rents a little bit. But part of it was the Fed doing its work and slowing things down a bit.

Our properties in Las Colinas have also improved a little bit. Retreat at Spring Park is actually 95% leased today, Verandah at Valley Ranch is 93%. So we're definitely moving in the right direction, but it just -- it hit those industries, I think, all at the same time, so that was the blip. They're stable. I don't -- we don't have a whole lot of product that is coming up in and around our assets because I would call them more core, a lot of the occupancy issues in Texas are with newer properties further out on the loop, they might be 40 minutes to an hour outside of the city where we're literally wedged between both airports. So it's a different submarket if that makes sense.

[Khing Shan, analyst]

Yes. Okay. And so if we were to think about 2025 for the U.S. portfolio, how do you see occupancy and rents trending in '25?

[John Talano, executive]

I think we had some tremendous growth over the last several years, and it's going back to normal. So we've budgeted 3.5% to 5% annually on average over the years. And you could go back and look at our performance, those pre-COVID numbers. And I think we're going back there.

[Khing Shan, analyst]

3.5%, that's rent growth, right, you're referring to, or revenue growth?

[John Talano, executive]

Yes, yes. The rent, the rent we expect. We expect -- we don't expect the 10% year-over-year growth that we have had in the past. I mean, in the very recent past, I would say, depending on the market, we're looking at between 3% and 5% in rent growth across the portfolio.

[Khing Shan, analyst]

All right. And then just a follow-up on Canada then, Angela. So the -- you mentioned that holding rent, I'm assuming market rents are sort of flat. Is that what you're referring to? Are you seeing market rents actually starting to come down a little bit so far? And would that be your expectation as we move in '25.

[Angela Sahi, executive]

I think it will depend property to property. I mean when there's low vacancy, we can really dictate what we want to achieve in rent, but it's basically for these older buildings, it's $3 a foot -- or north of $3 a foot like even at Thorncliffe Park, we're only having a few units turn over, and it's when we do, it's close to $3, about $2.89 to $3.10, something around there. And Mississauga, it's definitely north of $3, $3.10, $3.56 for smaller units. So we're holding those rents. So yes, so compared to last year, it's definitely gone up.

I think we were in the high -- mid- to high 2s last year, so -- on turnover, so it's definitely gone up, but it probably will plateau around here. There's only so much further we can go when you're competing with new construction and condos and things like that, I don't know that we could achieve $4. But I think we're achieving pretty strong rents. And I think it depends on the property. We might have to reduce a couple as loss leaders and offer some incentives like in situations, as I mentioned before, when you have a big parking project going on or something like that, but they'll still be high.

[Operator]

We have no further questions. I will turn the call back over for closing comments.

[Paul Miatello, executive]

Thanks again, everybody, for attending the call, and we look forward to speaking to you next quarter. Thank you.

[Operator]

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