Canadian Apartment Properties Real Estate Investment Trust (OTC:CDPYF) Q3 2022 Results Conference Call November 9, 2022 9:00 AM ET
Company Participants
David Mills – Investor Relations
Mark Kenney – President and Chief Executive Officer
Julian Schonfeldt – Chief Investment Officer
Stephen Co – Chief Financial Officer
Conference Call Participants
Mark Rothschild – Canaccord
Jonathan Kelcher – TD Securities
Johann Rodrigues – Industrial Alliance
Kyle Stanley – Desjardins
Brad Sturges – Raymond James
Mike Martinez – BMO Capital
Khing Shan – RBC Capital Markets
Matt Kornack – National Bank Financial
Mario Saric – Scotiabank
Operator
Good morning. Thank you for attending today’s Canadian Apartment Properties Brief Third Quarter 2022 Results Conference Call. My name is Alexis, and I will be your moderator for today’s call. [Operator Instructions]
I would now like to pass the conference over to Mr. David Mills. You may proceed.
David Mills
Thank you, Alexis, and good morning, everyone. Before we begin, let me remind everyone that the following discussion may include comments that constitute forward-looking statements about expected future events and the financial and operating results of CAPREIT. Our actual results may differ materially from these forward-looking statements, as such statements are subject to certain risks and uncertainties. A Discussions concerning these risk factors, the forward-looking statements and the factors and assumptions on which they are based can be found in our regulatory filings, including our annual information form and MD&A, which can be obtained at sedar.com.
I’ll now turn things over to Mr. Mark Kenney, President and Chief Executive Officer. Please go ahead, sir.
Mark Kenney
Thanks, David. Good morning, everyone, and thank you for joining us. Stephen Co, our Chief Financial Officer is with me this morning, as is our Chief Investment Officer, Julian Schonfeldt. You may have noticed on our opening slide that we are celebrating our 25th anniversary as a publicly traded REIT. Founded in September 1997, CAPREIT has grown to become Canada’s largest REIT with assets exceeding more than 17 billion.
I’ll have more to say about the significant milestone later in the call. Turning to our results on Slide 4. It was another solid quarter for the REIT, with revenues and NOI up on strengthened occupancies, higher average monthly rents and the contributions from our acquisitions over the last 12 whiles. NFFO was flat primarily due to inflationary cost pressures. Turning to Slide 5.
Our results for the first nine months of 2022 remain solid. Again, strong occupancies rise to 98.1% from 97.9% last year. Higher monthly rents and portfolio growth continued to drive increases in revenue and NOI. NOI and NFFO continue to be impacted by the increased costs we are experiencing, higher maintenance costs, the increase in utilities and higher realty taxes. We believe such inflationary cost pressures will continue to impact the results over the next few quarters.
And we are employing a number of programs to mitigate these inflationary pressures. In May this year, we began purchasing our trust units for cancellation under our approved normal course issuer bid. As of the end of the third quarter, we have purchased approximately 4.4 million units for an aggregate purchase price of $202 million. We believe, given that our units are trading at a significant discount to our net asset value of $56.44 at quarter end, that these purchases are another way we’re enhancing long-term value for our unitholders. From an operations perspective, coming out of the pandemic, we are now seeing near full occupancies and growing revenues across our stabilized portfolio, as shown on Slide 6.
Occupancies improved again in the third quarter, while net average monthly rents continue to increase. As I mentioned, we are also exploring a number of ways to mitigate the inflationary pressures on our cost structure, including fixing our price and transport costs for the natural gas we use and increasing [indiscernible] in our Canadian portfolio. As of quarter end, approximately 65% of the total 59,683 suites in Canada are sub-metered or directly metered. Additional suites and sites have sub-metering or direct metering in place that will be assumed by new tenants on turnover. We continue to evaluate implementing submetering in all of our remaining suites and sites.
Sub-metering lowers cost consumption, resulting in a smaller environmental impact, lowering operating expenses and lower inflation exposure. Our leasing and marketing programs continue to generate increasing occupancies and average market rent, as you can see on Slide 7. After two years of operating under significant pandemic restrictions, our occupancy continues to strengthen, rising to 98.1% in the third quarter, up from 97.9% last year. You can also see that rents for the total portfolio have risen 3.4% compared to the same time last year. Tenant incentives are continuing to decline to pre-pandemic levels, and we expect the majority of the amortization to be completed by the end of the year.
It is interesting to note on Slide 8, a positive trend in rent increases on turnover we are generating since we bottomed out at the height of the pandemic in Q1 last year. Looking ahead, we are experiencing more in-person and online visits, and we expect we will start to see more and higher mark-to-market rent increases in the quarters ahead.
I will now turn things over to Julian to outline how we are repositioning and strengthening our property portfolio.
Julian Schonfeldt
Thanks, Mark. Turning to Slide 10. We continue to focus on increasing the quality of our portfolio through our active asset management program. Through 2021, our strong acquisitions team added 3,744 high-quality suites and sites to our portfolio, focusing on our key markets with another 1,537 suites and sites acquired to date in 2022. Importantly, the majority of our acquisitions represent new build assets in strong targeted geographies.
These new additions to our portfolio are in line with CAPREIT strategy of rejuvenating its asset composition and increasing our geographic diversification into desirable major markets in Canada. Additionally, we’re happy to contribute to stimulating the market for new build multifamily assets contributing to the increase of new supply in Canada. Looking ahead, our acquisition pipeline remains strong, and we intend on leveraging our best-in-class acquisition and operating platforms to generate further accretive portfolio growth in the quarters and years ahead. Highlighting our growth strategy are two strategic acquisitions completed during the third quarter as detailed on Slide 11. Both properties are new, located in key growth markets, not subject to rent controls and both feature numerous amenities desired by phase discerning residents.
With newbuild properties, we also reduced our future capital investment needs and enhance our environmental footprint compared to more value-add properties. In addition to acquisitions, CAPREIT is also using dispositions to advance its core capital allocation strategy. CAPREIT’s $17 billion asset base as a result of 25 years of acquiring operating and enhancing multifamily properties. Some of our assets were bought decades ago with strategic criteria that no longer perfectly align with our current strategic objectives, making some of those assets noncore. Many of these noncore assets continue to attract premium pricing and generate fits that are above our IFRS NAV.
As shown in Slide 12, we’ve been selectively executing dispositions, which have so far amounted to almost $350 million in 2022. These strategic dispositions not only enhance the quality of our overall portfolio, but also result in disposition gains and introduced an incredibly attractive source of capital to fund our capital deployment priorities, which we previously discussed being our new build acquisitions and NCIB program. We’re committed to increasing the quality of the portfolio and enhancing returns in unitholder. A key component of our capital allocation strategy is our NCIB program, as shown on Slide 13. By selling certain noncore assets at or above IFRS NAV and repurchasing units at a major discount to NAV, we are arbitraging the significant spread for our unitholders while concurrently enhancing portfolio quality.
Year-to-date, CAPREIT has spent $202 million on an NCIB program having purchased 4.4 million units. As you can see on Slide 14, we are making real progress in repositioning our portfolio to reduce our exposure to older value-add properties and increasing our presence in new build properties and MHC sites in markets where CAPREIT wants to increase exposure. Our strategy is enhancing our portfolio quality, diversifying our tenant base and geographical exposure, decreasing our operating expenses and CapEx exposure in these inflationary times and ultimately enhancing our risk-adjusted return profile.
With that said, I’d like to thank you for your time this morning, and I will now turn things over to Stephen for his financial review.
Stephen Co
Thanks, Julian, and good morning, everyone. As you can see on Slide 16, our balance sheet and financial position remains strong and flexible at quarter end with a conservative debt to gross book value and continuing high liquidity. Our $1.3 billion in Canadian unencumbered properties, which includes the majority of our MHC properties, provides additional liquidity should it be needed. Looking at our financing through the first nine months of 2022, we locked in interest rates of 3.15% on our refinancings and extended our term to maturity. We expect to finance a total of $1.1 billion in mortgages and top-ups in 2022.
Importantly, over 99% of our mortgage portfolio incurs a fixed interest rate, protecting us from potential future interest rate increases. In total, if we were to access all of our available sources of debt capital, we would have approximately $1.2 billion available at quarter end. Slide 17 shows we are successfully controlling our interest cost in Canada and extending the term to maturity. In fact, our strategy to leverage 10-year CMHC insured mortgage debt has resulted in CAPREIT having one of the longest terms to maturity and lowest weighted average interest rate among our publicly traded peers. This provides us with a strong protection against renewal risk given where interest rates are at today.
Additionally, another benefit of our disposition program is lower reliance on debt. As I mentioned, over 99% of our mortgage portfolio incurs a low fixed interest rate, protecting us from expected future rate increases. As of today, we have launched approximately 77% of our 2022 maturity mortgages at a 3.19% interest rate. Further to our strong and flexible financial position, looking back over the last few years, you can see on Slide 18 that we have met our goal of maintaining very conservative debt and coverage ratios even through the pandemic. This conservative approach underpins the stability and resiliency of our business and the sustainability of our monthly cash distributions to unit orders.
This focus on maintaining one of the strongest balance sheets and our business will continue going forward. Our mortgage portfolio remains well balanced, as shown on Slide 19. As you can see, in any given year, no more than 14% of the total mortgages come due, thereby reducing risk in a rising interest rate environment. Looking ahead, our current ability to top up renewing mortgages through to 2036 will provide further significant liquidity in the future. As we expected, interest rates have risen after the Bank of Canada announced rate increases so far this year.
In anticipation, we moved up the refinancing opportunities for our 2022 matured mortgages from the second half of the year by paying some hedge costs and prepayment penalties, and we were able to achieve financing cost savings through closing of pre-locking rates for those five- and 10-year mortgages. Their rates were 2.8% and 3.3%, respectively, lower than the current five-year and 10-year estimated rates of approximately 4.2%.
I’ll turn things back to Mark to wrap up.
Mark Kenney
Thanks, Steve. Looking ahead, we continue to see a number of very positive value drivers as we’re confident will generate strong and growing returns for our unitholders over both the short and long term. We will continue to focus on our proven asset allocation strategy as detailed on Slide 21. On the apartment front, we are primarily targeting the acquisition of new build, modern properties in well-located markets in Canada’s strongest markets. Yields are attractive.
Growth is strong and stable and CapEx is modest. We’ll also see — we are also seeing condo rental rates increasingly significantly in major urban centers, increasing the appeal of our more affordable rental rates. With respect to our MHC focus, revenue and revenue growth are as robust as our apartment properties and have a very low risk profile. With residents owning their own homes, CapEx and maintenance needs are significantly reduced. Additionally, homeownership costs rising significantly across the country.
CAPREIT’s large MHC portfolio provides an affordable alternative for families looking to for quality residence at a truly affordable cost. Our third focus is on our NCIB program. While all of our unit price remains disconnected from the strong pricing we are seeing in the private markets, we’ll continue to crystallize the value spread and execute instant value creation for our unitholders. Key to our growth in the coming months will be our ability to capitalize on a number of market trends. Demand for our quality properties is growing as immigration accelerates with new Canadians seeking affordable homes in our largest urban markets.
The return of international students is also contributing to increased demand. The pandemic generated what we call household consolidation as students and young people returned home to save on costs. These young people are now moving back to rental accommodation as offices reopen and in-class learning returns. Demographics are also on our side as the growing seniors population looks to the rental market to meet their needs. We believe our quality and well-located properties offering more space on one floor at affordable rates, we’ll see increased demand by seniors looking to capitalize on significant equity in their homes.
We also see families looking to quality rental accommodation, including our MHC properties as a highly affordable alternative to the increasing cost of homeownership. Additionally, cash flows will increase as we prudently and responsibly increase rents. Finally, our ongoing property investments, as outlined on Slide 23, are helping to manage our costs and reducing our exposure to commodity prices through energy saving and other initiatives, increasing our operating efficiency through technology upgrades, enhancing resident safety and making our properties more attractive and importantly, helping us meet our ESG commitment to enhance environmental performance.
As I mentioned earlier this morning, we are extremely proud to celebrate our 25th anniversary in September. Over the last 25 years, CAPREIT has grown from owning interest in only 2,900 apartment suites in Ontario to where we can now have — we now have interest in approximately 67,000 suites, town homes and land lease community sites, well diversified across all major Canadian markets and internationally.Total asset value now exceeds more than $17 billion.
From the outset, our goal at CAPREIT is to provide high-quality, safe and pleasant rental housing experience second to none in our chosen markets. And we believe we are meeting this objective. By building a modern, high-quality portfolio, investing in our properties and leveraging the significant experience and commitment of our team, we are confident the next 25 years will generate further exceptional growth and value for our unitholders. In closing, we remain very excited about our future. Our strategy of acquiring new build properties increases portfolio quality, diversifies our asset base, reinforces revenue growth and reduces our CapEx exposure.
Our focus on high-end demand locations in strong Canadian markets is responding to population growth and is meeting the need for more housing space. We continue to leverage our best-in-class acquisition and operations teams to create value through our portfolio. Our industry-leading balance sheet leverage and liquidity position provide stability and the ability to grow going forward. And with demographic trends and increasing integration, we are confident we will continue to drive value for our unitholders in the years ahead.
Thank you for your time this morning, and we would now be pleased to take any questions that you may have.
Question-and-Answer Session
Operator
[Operator Instructions] The first question comes from the line of Mark Rothschild with Canaccord.
Mark Rothschild
Mark, you spoke about immigration briefly and that you would like to help address this. But your portfolio is pretty much full. It takes a while to build, and it’s not like anyone is going to be able to build enough anytime soon. So, do these new levels of new immigration the government is talking about, do they actually help you do they matter? Or is it just going to make it a tighter market overall for everyone?
Mark Kenney
Well, I think it helps the business by the lineup of people that we’re seeing for our product. We share the view, Mark, that the country needs more housing supply, and we’re doing absolutely everything we can to participate in that solution. That’s why we’re trying to focus on new build acquisitions. But we’re just — across the board, everybody you talk to now, the demand is surging even further because there’s a bit of uncertainty in the housing market. When you start seeing housing prices drift down, people get a little more cautious of investing in the market where do they go to rental.
So, we’ve got integration backups. We’ve got this housing value uncertainty, and we’ve got no clear line of sight on the path to really build what we need to build in this country, where we need somewhere the neighborhood just to get our heads around this $5 trillion to meet what CMHC views as the amount of housing our country requires to come back into balance. So, all of this is just backing up demand to never before seen levels.
Mark Rothschild
Okay. Great. And then you spoke about the single-family housing market slowing down. So besides for just maybe driving a little bit more demand, although most of the people that were looking to buy homes are not necessarily the core tenant for most of CAPREIT buildings. Does that impact your portfolio in any other way?
Mark Kenney
I disagree. I think especially in the new construction assets, it’s exactly that quality offering that people that are participating in the single-family home market are looking at as an alternative. I think that, again, you’ve been around long enough. You’ve seen it in the U.S. playout Mark, that when there is uncertainty in the housing market, there is surging demand in the rental market.
They correlate. We’ve forgotten all of this because rentals were doing good and good economic times from an affordability point of view. We forget I’ve been through multiple cycles where rental demand surges in bad economic times because of uncertainty. So, this is yet another tailwind in — behind our offering that I think our choice to move into this new construction, high-quality offering is going to really, really play it well for us. We’re already seeing it.
Mark Rothschild
Okay. Great. That’s helpful. Maybe just one more question. With the move in interest rates, you’ve tweaked or adjusted the cap rate using FRS very slightly, and it seems like there are still deals going on, but do you anticipate any further change based on the move-in rates?
Obviously, it’s more difficult to have a very highly profitable going in return, although the long-term rent growth is still there. So how do you see this playing out?
Mark Kenney
I see it playing out that all apartments are not the same. So, we are extremely fortunate to CAPREIT to have assets that have alternative value offering, okay? And what I mean by that, I think we talked about it on our investment day is a lot of developers are now turning to legacy product as their next pipeline of development. okay? So, what we’re seeing in the market is that your commoditized apartment building, if you have a suburban apartment building with no development opportunity and it’s a commoditized asset, then those values are going to be impacted with rising interest rates.
They’re strict yield play. But in the assets that have alternative value embedded in the asset themselves, those cap rates, if anything, are compressing further. So, it’s not about yield spread. It’s more about the specific assets that you own and whether it’s a commoditized asset or whether it’s an alternative value asset.
Stephen Co
I’ll just layer on to that, Mark, too. As we’re looking at acquisitions, I mean, cape rates one element of the return that people are looking at on an IRR basis and the other part that feed into that are CapEx and growth. And really, the growth, as Mark alluded to, is just completely been skyrocketing over the last few months. So, the interest rate environment hit it hard earlier. And it’s been kind of somewhat stable on the 10-year DOC and the three in the mid-3s now.
But every month, we continue to see the rent growth going higher and higher, and that’s been kind of putting in a closing pressure to the interest rate environment we’ve seen.
Operator
The next question comes from the line of Jonathan Kelcher with TD Securities. You may proceed.
Jonathan Kelcher
Thanks. Just following on Mark’s question there. I guess you talked a little bit about pricing and the different dynamics. But what are you seeing right now in the market in terms of deal flow? And do you think you guys will be net buyers or sellers of assets over the next few quarters?
Mark Kenney
I would like to think that we’re net sellers at above IFRS valuation with a very keen eye on market opportunities for new construction. So, we are absolutely continuing to underwrite new construction assets in key markets and very keen to pull out potential development value that we couldn’t exercise ourselves. And that strategy is holding up pretty well so far. Yes, I just going to say our focus is becoming better, not bigger. That is definitely the tagline in the office.
It’s all about being better, not bigger.
Julian Schonfeldt
Jonathan, just to recap on the strategy a little bit. We’re at a leverage level are generally pretty happy. So, the way we focus or fund our capital allocation is through dispositions now. So really, we sell something and then we allocate that to various buckets, either NCIB, the newbuild acquisitions or revolver repayment or some of the development initiatives. But when you run that through, that’s going to have us being in that seller given that all of that is funded by selling.
Mark Kenney
There might be some opportunities in the market, but I will not betray shareholders by issuing equity at these kind of discounts. There’s absolutely — that’s not on the table for CAPREIT at all. And we’re in a very fortunate position, like I said, Julian and the investment team being able to seek above IFRS valuation of some of the disputes. So, it’s a very unique moment in time.
Jonathan Kelcher
Okay. That’s helpful. And just switching to operations. The MHC portfolio, you had elevated costs in the quarter. Were they mostly onetime?
Or does some of that flow through to Q4?
Stephen Co
Yes. That is, I would say, costs that are more of an interim basis. We’re waiting for those [indiscernible] to be replaced it will probably be a number of quarters before we see those costs to stop. But I mean, we really — we’re working with the municipalities to get those approved and therefore, we can then replace those septic tanks and those costs, hopefully, will run out.
Julian Schonfeldt
It is a frustrating situation. CAPREIT absolutely wants to invest in infrastructure and go back to the municipal process being a challenging one. And so, it’s not a matter of anything more than municipal delay in replacing infrastructure.
Stephen Co
Yes. So, Jona just I’m guessing you’re asking for your mall anywhere between six to 12 months behind there is what we’re expecting, but it’s really kind of out of our control.
Mark Kenney
Yes, we’ll do outreach once we have better clarity on time lines.
Jonathan Kelcher
Okay. And then I guess just another modeling question. How should we think about margins in Q4 for the apartment portfolio compared to last year given that like the utility costs are still lapping an easy year-over-year comp.
Stephen Co
I think you can use like last year as a basis, we’re fairly comfortable. I mean there’s still some inflationary pressures, and we talked a little bit about the septic tank maintenance cost. So, you see a little bit of pressure there. But overall, if you use Q4 last year as a basis for this year, that’s a good start point and just play it into the septic tank and a little bit of inflation pressures.
Operator
The next question comes from the line of Johann Rodrigues with Industrial Alliance. You may proceed.
Johann Rodrigues
The Montreal was little bit soft. How is the international student recovery in that market going?
Mark Kenney
Yes, I’d say it’s good. The problem is, again, a slow supply coming to market at the same time. Montreal continues to produce one of the highest per capita condo rates in the country in terms of the development. So, it’s just an absorption at this point. I wouldn’t call it a market trend; I’d call it an absorption issue.
Julian Schonfeldt
And Johann, another thing to layer on is, as you know, in Quebec, the leasing is the majority of it is done for July 1. So, you really have to kind of look more towards there to see anything major trends. There’s not too much leasing that goes on throughout the rest of the year. So, stay tuned to see how it does end.
Johann Rodrigues
Right. Okay. And then just on Jonathan’s question on the [indiscernible] side. I understand the costs reelevated but the revenue was also down on a same property basis. Was that due to occupancy slippage due to septic tanks or what’s behind that?
Mark Kenney
I think it’s probably some occupancy issues, but not a lot related to the septic tanks.
Johann Rodrigues
Okay. So just your occupancy then?
Mark Kenney
Yes.
Johann Rodrigues
Sorry, one more. First line memory is the expected degree of dispositions for 2023.
Mark Kenney
Targeting?
Johann Rodrigues
Yes.
Mark Kenney
Yes, for a targeted acquisition number?
Johann Rodrigues
No disposition.
Mark Kenney
Disposition. It’s hard to say. I would say, very fair to assume same kind of quantum as 2022. Obviously, our ambitions on that front are a little higher, but it’s difficult for me to say Johann.
Julian Schonfeldt
Yes. I mean I know last quarter; we touched on a $600 million to $700 million list. And I’ll comment that, that is ever changing some things at added and things get taken off. We’re not at all to panic sellers. So, we’re very much a strategic seller.
So, whatever makes sense to have on there or not is what we’ll do, and we’ll never sell on desperation at a discounted price. So sometimes things will have to get taken off the list if we don’t get what we like, and we’ll add on as we go through our disposition process.
Operator
The next question comes from the line of Kyle Stanley with Desjardins. You may proceed.
Kyle Stanley
Just building on the dispositions there. I’m just wondering, what are you seeing out of the potential buyer pool? And I guess what are your expectations of being able to execute just given the overarching macro and interest rate environment that we’re kind of advancing through here?
Mark Kenney
Well, I’m going to — I’ll give you a problem more insight than I should. I would say that the Tier 1 buyers of apartment buildings in Canada have taken a step back, which has allowed the Tier 2 privates a real chance to step up on an opportunistic basis. So really what this means is a lot of sellers would value track record of the likes of CAPREIT as an example of being clean closers. And even if they have pricing the same or slightly better from a private, they were less likely to engage with an unknown name than they were a reputationally sound bank. So, the reputationally sounding have taken a bit of a step back, which has allowed some of the privates to come in with aggressive pricing without track record.
So, the bet that we’re making on some of these transactions is that they will actually complete but because their lack of track record. And that is not a typical path for a seller, but it’s one that we’re finding opportunistic. So, in our case, we’re seeing sales above what we would have thought the market would have paid because we’re allowing these Tier 2 buyers to step up.
Kyle Stanley
Okay. No, I think that’s some good insight there. You did mention, obviously, the enhanced focus on new construction. And is there a point where you would look to be an equity provider or a funding partner with a developer to enhance that pipeline or maybe a group of developers? Just trying to think about that as you look to advance the kind of new build side.
Mark Kenney
There’s so much opportunity in the marketplace. We don’t really have to pursue things like that. But I want to say, too, it’s interesting. It’s really the strategy is nothing new for CAPREIT. If you go back really since I became the CEO, and actually, when I started doing all the Canadian acquisitions, it’s been an absolute focus on new construction.
We’re just broadcasting it more, and we’re really out of the value-add business now. So that’s a slight tweak. But if you go back and look at the composition chart that Julian touched on in his presentation, I think we’re making some pretty good progress here. But there’s no real change. We would do this for a few years now.
Kyle Stanley
Okay. And just last one for me. I mean, looking at some of your geographies, could you compare and contrast what some of the differences are on the OpEx side? I mean Alberta where inflation was elevated this quarter versus costs that were fairly contained in BC. I’m just wondering if there are specific drivers to that? And if you can comment.
Stephen Co
There’s no specific drivers. I think we’ve seen elevated cost and inflation. I mean MHC, for example, was a septic tank maintenance. So, it’s just really — it’s very area specific, but there — you can say the drivers are really inflation related.
Julian Schonfeldt
Yes. The only other — the only thing I would really point to that we can see, and I think you’re seeing it possibly with peers is on the demand side, the laggard is definitely Quebec, Montreal and that’s really the only thing that kind of steps out as being material.
Operator
The next question comes from the line of Brad Sturges with Raymond James. You may proceed.
Brad Sturges
Just on the leverage, I think, Julian, you touched on it, I think the leverage is about 40%. I guess if you’re thinking through all the allocation decisions with capital coming from the disposition program, we should be assuming that you’re seeking to hold leverage around the 40% level here today.
Julian Schonfeldt
Yes, generally speaking, like I said, we’re looking to allocate between the three buckets, but we’re pretty happy with where leverage is. Again, to the extent that we don’t have great acquisitions if we’re not happy with the NCIB pricing, neither of which is the case at the current time. But if that was the case, and then we have a revolver we can pay down.
Stephen Co
The target for us is we’re targeting around 35% to 40% leverage. I mean there may be periods where it may be slightly elevated, but our plan is always to be just under 40%.
Mark Kenney
We hope to go through a bit of a delivering exercise here as the dispose pile up. But we’re also so conservative on our valuations that we’re kind of holding ourselves back to what we need real progress because we want to be very conservative on the valuation front. So even though we’re not entering into some [indiscernible] during these more expensive time our leverage, it’s going to hold right around that 40% mark as we see conservative on that.
Brad Sturges
Okay. As you continue to pivot towards new build assets, do you have a kind of a medium target — medium-term target in terms of the weighting in the portfolio you would like to get to?
Mark Kenney
The way we’re going to do this is, again, right back to the [indiscernible] program. We’re going to wait for things to close. When that one is in hand, we’re going to allocate between our NCIB new acquisitions and pushing off REFI. And it will be a bit of a mixture of all. With the primary focus of the long-term vision of the company is a high creating exercise.
So, the least attractive opportunity, quite frankly, are probably some of the immediate brand-new construction assets. But long term, they will probably turn out to be the best investment. It’s hard, though to turn away from the NCIB, and it’s very difficult to turn away from a guaranteed accelerated interest costs on REFI. Like that’s the guaranteed way of return. You’ll see each quarter, and it will go into one of those three buckets or all three.
Brad Sturges
Maybe last question. Just the — on the mark-to-market, obviously, it accelerated in the quarter, and you’re talking about demand surging, where do you see that trending in the next couple of quarters? Do you see it continue to accelerate through the slower or the winter months? Or do you see more of a stabilized mark-to-market in Q4, Q1 and then more of a pop again in the spring?
Mark Kenney
You can continue to use the same rule that you were using in lost work. It will [indiscernible] at some point. But right now, it’s — like I said at the beginning of the call, the demand is just packed right up.
Operator
The next question comes from the line of Mike Martinez with BMO Capital. You may proceed.
Mike Martinez
Two from my end. I guess just circling back to your comments at the beginning of the call, you talked about some strategies that you were undertaking or thinking about undertaking to fix the price and transport costs on the utility side. And I was just wondering to begin with, if you could talk about how that would change from what you’ve employed historically or what you currently have in place.
Julian Schonfeldt
Yes. Hi Mike, so we have a hedging strategy. We’ve done it — we typically hedge three years out. This year, we were close to like 90% hedged. Next year, I think we’re close to 60% to 70%.
At these current rates, I don’t think we’re going to be hedging any further on the unhedged component, but we’ll continue to observe the market. If there is any good opportunity, we will. But right now, at this point, we’re going to just keep with the hedges that we have in place.
Mark Kenney
We are hopeful we’ve invested pretty heavily in our procurement department. And I think we touched on that. We assembled a new team. We’re very, very hopeful that will also help. I think though [indiscernible] Steve, I’m a little embarrassed to some of these onetime costs that keep showing up on the expense front, but septic tank issue in particular.
But we feel that inflation is baked in now. If anything, we’re doing more optimistic on utilities. And in terms of other inflated factors like wages and property taxes and even repairs and maintenance, we think that there’s stabilized effect there now.
Mike Martinez
Okay. Great. And then just lastly, I guess there’s been some media attention with respect to a focus at the tribunal to speed up a big backlog of AGI applications. If they’re successful, and I guess that’s a big if, is that something that could potentially be a tailwind for you in Ontario? Or is it not material in 2023?
Mark Kenney
It’s a tail of breeze. It helps, but it’s not something we’re going to count on also 2023 over.
Mike Martinez
Okay. Tail breeze, Mark, you always come up with these great [indiscernible] thanks for that. Great to connect again, and congrats on the quarter.
Operator
The next question comes from the line of Khing Shan with RBC Capital Markets. You may proceed.
Khing Shan
Just on the inflationary pressures again. So how should we think about expense growth next year? Year-to-date, you’re tracking 7% or 8%, but you’re seeing — you seem to be saying that this inflation have kind of baked in. So, is it your expectation that this pace of growth on a year-over-year basis next year will look about the same or accelerate or decelerate?
Julian Schonfeldt
I mean, in my opinion, I think that we will — we don’t see the elevated inflation that we saw this year. But I think we’re still seeing still inflation pressures in certain categories. So, in my opinion, I think if you were to for modeling purposes, I would still build it like 4% to 5% inflation pressure overall. With an acceleration in mark-to-market rents, the mark-to-market rents, the churn has really slowed down, like we’re just touching on double digits. But the mark-to-market story is very strong, unprecedented.
Khing Shan
Right. Okay, so 4% to 5% of the expense growth, that would supply that things would decelerate somewhat is kind of would be your best guess at this stage.
Julian Schonfeldt
Yes.
Khing Shan
Okay, and then I apologize, the septic tank maintenance costs and the manufacturer business, I actually don’t quite follow like what’s going on there like what makes it interim? Like how does the municipality delay cause the cost to increase? [indiscernible] comment on that.
Julian Schonfeldt
We have five different sites that all have reached in our mind, end of useful life. We take remarkable steps to make sure pumping and testing is done when we identify sites being at end of useful life. And it’s simply getting the new infrastructure put in place like we’re placing them all. So, it’s a planned activity that we’re stuck in this holding period of the life safety purposes, health safety purposes, doing all the necessary things required to keep things safe. And it’s frustrating because we’re ready to go on the project front, but we need the approvals.
So, when the approval process comes up, there’s all kinds of things with the municipalities. They have crossover approvals for multiple departments. So, we’re pushing hard here. It’s frustrating because we’re trying to do the right thing. But there’s ongoing maintenance expense — accelerated maintenance expense until you can actually do the disconnects and put in the new tanks. Then it goes away for 30 years.
Khing Shan
Right. Okay. I understand. But the actual cost itself would be capitalized and not expensed at —
Mark Kenney
[indiscernible] yes, this expense completely disappears the — once the new tanks are put in place.
Khing Shan
Okay. And then last question for me on the disposed side. Maybe if you could comment on kind of as you look at that list, have you put assets in the market and the kind of falling through? And you spoke about the Tier 2 buyers. And I’m just kind of wondering, do they have access to financing or are you having to do more VTB type deals to get some of the sales done?
Mark Kenney
I’ll let Julian feel that. Our appetite for VTB has been nonexistent, but I’ll let Julian take that.
Julian Schonfeldt
Yes. No, assets with in-place financing tends to attract more interest. But we have a couple of portfolios in the market. One is actually with some of your colleagues, Jimmy. But other than that, a lot of it’s been off-market approaches.
And so, you get developers, you get folks assembling land that may be owned properties across the street or to the side or have operational efficiencies and it’s a lot of those private buyers that market. We’ve got a few requests for VTB. It’s been something we haven’t been really entertaining at this point. To the extent that we get really premium pricing, and it was something that was completely necessary to bridge a transaction and then sure, we might consider it. But we’re not a bank, and we’re not in that business, and it’s something we’re going to try to avoid.
Operator
The next question comes from the line of Matt Kornack with National Bank Financial. You may proceed.
Matt Kornack
Just a quick follow-up on Jimmy’s question there with regards to margins. Is there anything within R&M that you can potentially get efficiencies on going forward or that is controllable. And it sounds like I know last quarter — sorry, Q4 of 2021, there was accelerated maintenance and then the winter weather was pretty bad in Q1. So those seems like they’d be potentially transitory issues that wouldn’t necessarily recur in early 2023, but any sense there as to potential savings?
Mark Kenney
Yes. Again, I talked about septic tank. But here we are, again, that is an expense that we will stop as soon as the projects are completed. We’re very aware of the onetime nature of the expenses that we’ve been talking to quarter-by-quarter. Sadly, as I said to Stephen, this morning, we had a number of onetime events that are not trending.
It’s just, again, the latest one is outside of what we would see as normal same-store costs. So, the answer to your question is, like I said, I believe that the inflation is baked into the expense lines. We’re not seeing the acceleration that we were, and there has been a stabilization there. And yes, I would just say like we’re expecting improved margins because of revenue gains. We’re expecting improved margins because some of the disposals that we are doing are lower-margin assets and the acquisitions are higher-margin assets.
There’s totally, as we said, efficiencies in utilities in terms of our hedging program, the kind of pricing that we’re seeing going into this winter is better than what we saw last. The environmental energy programs that we put in place this year will really kick in into Q3 — sorry, Q4 or Q1. So, a variety of factors, Matt, I think it gives us a great deal of comfort that we’ve got stability in the margins, if anything, improvement in the margins.
Matt Kornack
Okay. No, that’s helpful. We’ll model 4% to 5% and hope you beat us on that front. One other — I guess two other quick ones. On alternative value, I think you’ve done a bit more work with regards to entitlements and looking at the potential within the portfolio with regards to density.
And then obviously, you have the province out trying to encourage development and reduce time lines in Ontario that is. Can you give us a sense as to how your thoughts have changed potentially or if there has been any change in terms of the opportunity set within the portfolio, not necessarily that you’d execute on it, but any view there?
Mark Kenney
I’ll let Julian respond, but I’d like to thank you for management’s response because you just gave it. The reality is there is far more of an appetite and pressure we put on municipalities to loosen up on this spread, that has tremendous effect. And the team orientation at CAPREIT has 100% moved into entitlement preparedness. And I’ll let Julian build on that.
Julian Schonfeldt
Yes. So pretty much the strategy now. It’s been just looking at high land value sites and going through the entitlement process and afterwards deciding what we’re going to do there, and that could include any range of outcomes. But right now, the bias is more towards getting the sites and titled realizing the higher land value and potentially selling and redeploying that otherwise 0 yielding asset into our core business being right now, the newbuild properties. But so, you saw in the property tour one of the sites that we had entitled in February and we are working on a couple of other sites here in Toronto that are very attractive to us, where there’s a completely underutilized adjacent land and going through those entitlements and see what we come up with. But that’s really the focus on the development strategy now.
Matt Kornack
Okay. No, that’s fair enough. We look forward to seeing what you guys find out there. My last question is not material, we’re coming up on time, so I’ll leave it there.
Mark Kenney
Call us any time, [indiscernible] talk to you.
Operator
The next question comes from the line of Mario Saric of Scotiabank. You may proceed.
Mario Saric
I’ll continue on the theme of just talking about the operating cost, maybe from a slightly different angle. So, you’ve provided a lot of color on the call already. One of the Q4 ’21 expense was impacted by what we felt was kind of a bring forward of expenses due to not being able to get into people’s suites and whatnot, the common areas due to COVID. Like that description in the disclosure is still there in this quarter, at what point does that go away in terms of the higher cost driven by [indiscernible] simply work.
Mark Kenney
Yes, that is — that will have been bled off in Q4 of this year. There [indiscernible]
Stephen Co
Yes. I think we’re seeing the — last year, we were incurring a lot of R&M costs relating to the deferred maintenance around the tenant suites. But then we’re now offset by some of the inflationary pressures that we’re seeing built into our margin. So, I just said typically a little bit more conservative to say that if you look at Q4 margin, I would use as a basis for this year, if you were to project that out for Q4 2022.
Mario Saric
Okay. And then just switching to the capital allocation strategy. Again, you provided a lot of color, but just to be clear, in terms of kind of a net buyer or a net seller, it sounds — is it fair to say that it’s very unlikely for you to be a net buyer in the next 6 months, meaning that any acquisition opportunities on the new build side are really going to be contingent upon closing some of the assets that you have in the market for disposition. Is that a fair comment?
Mark Kenney
Yes. For clarity, we’re a net seller because just by having the NCIB and the REFI use, you have to be in that. We’re not going to insure more debt. So yes, we will be taking our [indiscernible] money will buy new assets on a selective basis. We will be exercising our NCIB, and we will be putting off a REFI where applicable.
So that, by definition, just as we’re in a teller.
Mario Saric
Got it. And do you have any sense in terms of the amount of net selling that could be accomplished this year or into ’23 without the requirement of providing special distributions to other based on what you’re looking to sell?
Mark Kenney
Well, I think the cap gains lead to a conclusion here of something have, I’ll let Stephen [indiscernible]
Stephen Co
We’ve done some calculation. There’s likely going to be something we’re going to — there will likely be a special distribution this year. But we’re likely going to announce that later in the month — or sorry, in December when we finalize the numbers because we still have two months ago in terms of where our taxable position will be, but we’ll be announcing something in the coming months.
Julian Schonfeldt
And I wouldn’t underwrite any significant dispositions for the rest of the year. That’s what Stephen is saying is based on what’s kind of already closed, and we’re getting close to kind of the end of the year now, so I think most of the disposition activity is going to be focused next year, Mario.
Mark Kenney
And to answer your question on Quantum, Mario, again, we’re cautious because we’re dealing with a more unproven Tier 2 private buyer group. And so, we are actively looking at opportunities, but cautious on completion. Julian said we’re not aspiration to sellers here, it’s opportunistic.
Mario Saric
Yes, so when you look out into ’23 on that front, presumably income will be higher in ’23 relative to this year, if you continue to see that revenue growth that you’re talking about. How do you think about reallocating capital from asset sales in the event that the requirement for increasing special distribution is there, does that change the quantum of assets that you’re looking to sell and the quantum of assets you’re looking to buy?
Mark Kenney
No. All I can say is that we are fully committed to the CAPREIT balance sheet. And I will — I’m focused on getting better, not bigger. And I’m absolutely focused on growing earnings per share, not the size of the company. So, decisions around what to do with the capital generated from these positions will be fully, fully focused on improvements to the balance sheet.
Okay.
Operator
There are no additional questions waiting at this time. So, I’ll pass the conference over to Mr. Mark Kenney for closing it. You may proceed.
Mark Kenney
Okay. I’d like to thank everyone for their time and their attention today. And as always, if you have any further questions, please do not hesitate to contact us at any time. Thanks again, and have a great day.
Operator
That conclude the conference call. Thank you for your participation, you may now disconnect your lines.
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