Killam Apartment REIT (OTC:KMMPF) Q3 2022 Earnings Conference Call November 9, 2022 10:00 AM ET
Company Participants
Philip Fraser – President and CEO
Robert Richardson – Executive Vice President
Dale Noseworthy – Chief Financial Officer
Erin Cleveland – Senior Vice President, Finance
Conference Call Participants
Sairam Srinivas – Cormark Securities
Jonathan Kelcher – TD
Kyle Stanley – Desjardins
Mark Rothschild – Canaccord
Matt Kornack – National Bank Financial
Johann Rodrigues – Industrial Alliance
Operator
Good morning, ladies and gentlemen. And welcome to the Killam Apartment Real Estate Investment Trust Third Quarter 2022 Financial Results Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]
This call is being recorded on Wednesday, November 9, 2022. I would now like to turn the conference over to Philip Fraser. Please go ahead.
Philip Fraser
Thank you. Good morning. And thank you for joining Killam Apartment REIT’s third quarter 2022 conference call. I am here today with Robert Richardson, Executive Vice President; Dale Noseworthy, Chief Financial Officer; and Erin Cleveland, Senior Vice President of Finance. Slides to accompany today’s call are available on the Investor Relations section of our website under Events and Presentations.
I will now ask Erin to read our cautionary statement.
Erin Cleveland
Thank you, Philip. This presentation may contain forward-looking statements with respect to Killam Apartment REIT and its operations strategy, financial performance conditions or otherwise. The actual results and performance of Killam discussed here today could differ materially from those expressed or implied by such statements.
Such statements involve numerous inherent risks and uncertainties and although Killam management believes that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that future results, levels of activity, performance or achievements will occur as anticipated.
For further information about the inherent risks and uncertainties in respect to forward-looking statements, please refer to Killam’s most recent annual information form and other securities regulatory filings found online on SEDAR.
All forward-looking statements made today speak only as of the date which this presentation refers and Killam does not intend to update or revise any such statements unless otherwise required by applicable securities law.
Philip Fraser
Thank you, Erin. We are pleased with our strong financial and operating results for the third quarter. Our continued focus on our three growth strategies has resulted in an increase in same-property NOI of 5.1% and an increase in funds from operations of 3.3% for the quarter. The fundamentals are strong in our core markets, which has translated into same-property revenue growth of 5.1% and the highest occupancy in our history.
Based on our year-to-date growth, we have increased the same-property NOI guidance for 2022 to above 4%, compared to our original target of 2% to 3%. Our investments in Ontario, Alberta and BC over the last few years are increasing our NOI outside Atlantic Canada, which has been a strategic priority for Killam for the last decade.
Year-to-date NOI outside Atlantic Canada is 35.7%. The lease-up of the Latitude, The Kay and Luma, will further increase NOI generated outside Atlantic Canada during the remainder of the year. Looking further out, we are targeting over 40% of NOI coming from outside Atlantic Canada by 2025.
Based on the rapidly rising interest rate environment and volatility in the capital markets, we have taken a pause on acquisitions during the second half of the year. Acquisitions will continue to be an important avenue for Killam’s growth in the long term. However, we believe now is not the time to be aggressive on the acquisition front.
Although supply chain and labor constraints have pushed the completion of the Governor and Civic 66 over a couple of months from the original completion date, they are both exceptional assets that will enhance our existing portfolio. It will be great additions to Canada’s housing stock.
Dale will now discuss our Q3 financial results, followed by Robert, who will discuss our MHC commercial portfolio results in our repositioning program. I will conclude with an update on our current and recent developments and an ESG update.
I will now hand it over to Dale.
Dale Noseworthy
Thanks, Phil. Slide five [Technical Difficulty] Q3 financial performance. Killam earned net income of $3.6 million in the period and FFO per unit of $0.31, up 3.3% from Q3 last year. AFFO per unit of $0.28 was up 3.8% from Q3 2021.
Killam same-property NOI, FFO and AFFO growth in Q3 and year-to-date are summarized on slide 6. We had a strong quarter with topline growth of 5.1%, driven by higher apartment occupancy, rental rate growth and gains in both seasonal MHCs and commercial revenues. Killam’s apartment portfolio achieved 98.4% economic occupancy in Q3, 100-basis-point increase from Q3 last year.
The line chart on slide seven highlights the improved occupancy we have seen over the last year and a half. The chart at the bottom of the slide shows the strength across our portfolio. Six of our core markets achieved 99% plus occupancy in the quarter, including Calgary, which had been carrying higher vacancy for the last few years. Ottawa is another market where we saw a strong improvement in occupancy. Momentum continues in all our markets as we wrap up 2022 and head into 2023.
As shown on slide eight, we also saw a 10-basis-point reduction in incentive offerings this quarter. We expect this reduction to continue into Q4 and in 2023.
The weighted average rental increase chart on the top of slide eight captures the increase in rents based on the leases that came into effect during each quarter. This offers more current data than the year-over-year average rent increase results. In Q3, we achieved a weighted average increase of 4.2% for new and renewing leases that started in July to September.
This was made up of 2.1% rental growth for existing tenants with leases renewing in the period and 11% increase in unit rents on turn, representing new tenants moving in during the quarter. Same-property operating expenses increased by 5.2% in Q3.
Please refer to slide nine. As in the first half of 2022, utility and fuel expenses were up the most by 9.8% due primarily to higher natural gas prices. General operating expenses also increased by 5.5% in Q3 relating to inflationary pressures.
Killam’s debt maturity profile, which can be seen on slide 10 includes average apartment mortgage rates by year versus prevailing five-year CMHC insured mortgage rates. Following recent interest rate increases, current borrowing rates are above Killam’s weighted average interest rate.
During the first three quarters of the year, Killam refinanced $132 million of maturing mortgages with $177 million of new debt, the majority of which was for 10-year terms at a weighted average interest rate of 3.43%, 76 basis points higher than the rate on the maturing debt.
Refinancing at higher rates is expected to lead to increased interest expense. However, this increase is expected to be gradual due to the staggered nature of our debt ladder. We have been focused on reducing our debt levels for the last seven years and ended Q3 with debt as a percentage of total assets of 45%, in line with our strategic target for the year. Killam ended Q3 with approximately $79 million of capital available through its credit facilities. Killam’s debt metrics are included on slide 11.
I will now turn the call over to Robert, who will discuss our operating results in more detail.
Robert Richardson
Thank you, Dale, and good morning, everyone. We continue to see positive results across all of Killam’s business segments. Our MHC and commercial portfolios had strong quarters, and are expected to continue to add meaningful contributions to Killam’s growth going forward.
As seen on slide 12, Killam’s MHC portfolio realized same-property revenue growth of 7.7% in Q3 and our 9 seasonal resorts had very strong summer rentals, achieving revenue growth of 12.7% in Q3 and net operating income growth of 10.3% as highlighted on slide 13.
Slide 14 shows our same-property commercial portfolio, which also posted healthy gains in Q3, with revenues up 6.3% and net operating income up 6.6%. These improvements reflect increased occupancy to 92.5% in Q3 versus 89.6% in Q3 last year.
We are optimistic about the leasing momentum across our 1 million square feet of commercial properties. The commercial portfolio is proving to be very complementary to Killam’s apartment portfolio.
We continue to invest strategically in our portfolio with capital upgrades, energy efficiencies and unit repositionings. Year-to-date, we have repositioned 496 units and are on track to meet our target of 600 units for 2022.
We are experiencing strong demand and healthy rental growth as these renovated units come online. With an average investment per unit of $26,000, Killam generates an average return on investment of 13%. We are proud of the capital investments that modernize our portfolio, improving its efficiency and marketability.
Slide 16 is an example of a common area upgrade we completed in Q3 at Quinpool Towers, a 233-unit building centrally located on the Halifax, Peninsula. Due to its close proximity to downtown and both Dalhousie and St. Mary’s universities, this property has been attractive to students and young professionals since we acquired it in 20 — in 2004.
We identified the opportunity to deliver expanded amenity space, including opening up and renovating formerly unused space on the second level to create a social room, including a boardroom and a fitness center on the ground floor. These renovations have been incredibly well received by tenants and are expected to lead to record demand for this property.
Continued population growth is also expected to drive demand for our properties across Halifax. We hosted an analyst and investor tour in Halifax in early October and participants were impressed with the growth and vibrancy of the city.
As the chart on slide 17 highlights, population growth in Halifax has continued to remain at near record levels. The city is attracting people from across Canada and around the world. It’s exciting to see that young people are driving much of this growth.
The largest cohort of residents in Halifax is now 25 years old to 34 years old compared to 35 years old to 44 years old, 20 years ago. These young people are important for the economic growth of Halifax and its increasing vitality. Further, other cities in Atlantic Canada, such as Moncton and Charlottetown are also seeing similar population trends.
I will now hand you back to Philip to provide an update on our developments and acquisitions.
Philip Fraser
Thank you, Robert. 2022 has been an important year for Killam’s development program with the completion of three projects. We are very pleased with the lease-up of these properties as shown on slide 20.
The Kay, as seen on slide 21, was completed in April and was fully leased by August. The Latitude, on slide 22, opened in January and is now 93% leased. Both of these properties were built with geothermal heating and cooling systems, and are expected to reduce heating and cooling energy consumption by approximately 25% when compared to conventional system.
The Latitude was built adjacent to our existing building Frontier and provide 17,000 square feet of community space for our tenants, with amenities such as fitness center, yoga studio, social rooms, pet watch and a golf simulator.
With an average monthly rent of $3.05 per square foot, this demonstrates strong demand from tenants, who are turning to high quality apartments as affordable alternatives to homeownership. Luma, which opened to tenants in June, reached substantial completion in Q3 and is 62% leased.
Slide 24 shows the three remaining developments underway, the Governor in Halifax, Civic 66 and Kitchener, which were both expected to be completed — are both expected to be completed in early 2023.
And The Carrick, 139-unit building in Waterloo, which broke ground last quarter and is expected to take 36 months to build. This building will be Killam’s first use of PIRANHA Wastewater Heating Recovery System. This system includes a large storage tank in the basement where the PIRANHA heat pumps remove heat energy from the buildings wastewater and transfers it to the incoming water for domestic use in the units. This system is expected to reduce the building’s hot water energy consumption by over 400,000 kilowatt hours annually compared to a conventional heating source.
We are also registering the development as a condominium, which will give us the flexibility at a later date to sell a portion of all the units, a portion or all of the units or keep it as a rental building. Renderings, progress photos and key financial information on these active developments can be found on slides 25 to 29.
In October, we obtained our 2022 GRESB results earning an additional Green Star designation and a 15% score improvement from our 2021 rating. The Killam now holds a Green 3 Star designation and a public disclosure rating of A, outperforming the global scoring average of B.
Throughout the year, we have been investing in Green Solutions as highlighted on slide 30. With the opening of Civic 66, we will have six properties using geothermal heating and cooling, increasing our unit count to 1,021 apartment units.
We continue to invest in solar with the completion of our first installation in Alberta this quarter at the Vibe, making it our 17th solar installation in our portfolio and increasing our installed solar capacity to an estimated annual production of 1.7 million kilowatt hours annually.
Finally, we continue to prioritize certifying our building through various certification programs in order to ensure we are providing our tenants with the best operating and living standards. We are on track to certify an additional 1,500 units this year, bringing us to 13% of our portfolio certified and on track to meet our target of certifying 20% of our portfolio by 2025.
To conclude, we are focusing on producing high quality developments, providing high quality living standards for our tenants and investing in innovation green energy to reduce our carbon footprint, while mitigating our exposure to rising energy costs.
As seen across all regions, the fundamentals supporting, the rental housing sector in our portfolio are strong. We are optimistic in our ability to continue to grow NOI and net income. I would like to thank our team at Killam for their hard work and their dedication.
Thank you. And I will now open up the call for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Your first question comes from Sairam Srinivas from Cormark Securities. Your line is open.
Sairam Srinivas
Thank you, Operator. Good morning, everybody, and congrats on a good quarter. So, just going back to your comment on the Killam reaching peak occupancy this quarter, looking forward to the next couple of quarters, how should we think about the balance between rent growth and occupancy?
Dale Noseworthy
Well, it’s always a balance that we are looking for. I mean certainly, the momentum is continuing on the occupancy side. So on turns we will be maximizing those trends and we have got following guidelines in terms of renewals and in some markets where there’s a little more flexibility looking to maximize that too.
So looking forward, most of the topline growth is going to come from rent growth. There is still some occupancy when we look forward year-over-year. Calgary, as I mentioned in the comments, had been — Alberta has been carrying a little bit more vacancy than some other markets and Ottawa as well. So there’s going to be some opportunity, but managing that balance in the current environment where a lot of people are looking for a place to stay.
Sairam Srinivas
Thanks a lot, Dale. And just following up on that in terms of how your markets are looking, are there some markets that are fundamentally more attractive right now relative to others?
Robert Richardson
Not fundamentally. So there’s 12 major markets we report on and six would be at 99% occupied and so they are all strong.
Sairam Srinivas
Thanks, guys. I will turn it back.
Philip Fraser
Thank you.
Operator
Your next question comes from Jonathan Kelcher from TD. Your line is open.
Jonathan Kelcher
Thanks. Good morning.
Philip Fraser
Good morning.
Jonathan Kelcher
Just on the same-property NOI guidance that you bumped up to 4%. You are kind of running 5% year-to-date, so that would suggest the bottom end is kind of 1% growth for Q4 and I know you are pretty confident on the revenue side. So is that just utility cost, the unknown of utility costs, what’s kind of the drag there?
Dale Noseworthy
Yeah. Utility would be one. I mean, as we head into late fall, early winter and we have seen what’s been happening in terms of utility costs. So that would be probably the biggest piece.
Jonathan Kelcher
Well, I think, I said above 4%.
Dale Noseworthy
Yeah.
Jonathan Kelcher
Yeah.
Dale Noseworthy
No. That’s occupancy as well because year-over-year we were quite high in Q4 last year.
Philip Fraser
Yeah.
Jonathan Kelcher
Okay. Fair enough. And then on the repositioning program, you are going to hit your — hopefully hit your 600 number this year. Is that something we can — is that a number we can think about going forward or is that a program you can scale even a little bit more?
Robert Richardson
It’s a number you can think about going forward.
Jonathan Kelcher
Okay. I guess the last question, you talked about registering the Waterloo development — I think the Waterloo development has condos. Is that something you can think about going forward for more new developments just as a way to potentially to fund them?
Philip Fraser
Absolutely. I mean…
Jonathan Kelcher
Okay. Nice and quick.
Philip Fraser
I still…
Jonathan Kelcher
Nice and quick. I will turn it back.
Philip Fraser
Yeah. I mean…
Jonathan Kelcher
Well, that’s good.
Philip Fraser
The answer is relatively short.
Jonathan Kelcher
Lots of calls today. That’s good.
Philip Fraser
Yeah.
Robert Richardson
It gives you flexibility, Jonathan.
Jonathan Kelcher
Okay. Great. Thanks, guys.
Philip Fraser
Okay.
Dale Noseworthy
Thanks.
Operator
Your next question comes from Kyle Stanley from Desjardins. Your line is open.
Kyle Stanley
Thanks. Good morning, everyone.
Philip Fraser
Good morning.
Kyle Stanley
I just wanted to look at New Brunswick a little bit. I mean it continues to be very impressive. I am just wondering if you can just talk about some of the key drivers that you are seeing there that was contributing to the performance?
Philip Fraser
Well, I mean, it’s almost the same rate across the country. There is population increase in all three centers that we operate in and there’s lots of jobs for people in those markets, and I mean, I can’t ask for much more.
Robert Richardson
Yeah. Resource is strong and St. John is seeing a lot of work with its container shipments, the traffic is up markedly. So across the Board things are firing in all cylinders.
Kyle Stanley
Okay. Thanks for that. Maybe just turning to your development, I am just wondering what the NOI contribution from Luma would have been during the quarter and when you expect to achieve stabilization there?
Dale Noseworthy
Luma would have been very minimal in terms of, I mean, just coming on in Q3 and we are still in lease-up mode there. So it would be minimal.
Kyle Stanley
Okay. Okay. Fair enough. And then…
Dale Noseworthy
Stabilized looking, I mean, it will be, probably, between early mid-2023…
Kyle Stanley
Yeah.
Dale Noseworthy
… for stabilization there. So we are at 62%. We are really pleased with how lease-up going on there. But it’s going to take a few months to lease that up.
Kyle Stanley
Okay. Fair enough. And I mean, I guess, just sticking with development and looking at the Governor and Civic, I mean, we got to tour of Governor when we were in Halifax. I am just wondering, can you speak to any early developments on the leasing programs there as you approach completion early next year?
Philip Fraser
Well, we have got two to three spoken for and the effort is to get those folks in as fast as we can. So we are looking, hopefully, the first people moving in sometime either in February or March. And I think the activity we have been holding back relative to showing what the product is going to look like and we are quite comfortable and confident that there will be quite a bit of demand once we finish it and people can walk through and see the units.
Kyle Stanley
Got it. And we…
Philip Fraser
Civic 66…
Kyle Stanley
Yeah. Go ahead.
Philip Fraser
Civic 66, again, a little bit behind, but we believe we are going to have the first six floors open, the 1st of February, maybe as late as the end of February and we have got some pretty strong pre-leasing already.
Kyle Stanley
Okay. Great to hear. Thanks for that. I will turn it back.
Operator
Your next question comes from Mark Rothschild from Canaccord. Your line is open.
Mark Rothschild
Thanks. Thanks. Good everyone. The development clearly has worked well over the past number of years. Going forward, do you anticipate rising cost to cause you to rethink some of these projects or does it starting new projects or is this an impact the going in yields or is the rent growth enough to offset all that and make it something you want to continue in a big way?
Philip Fraser
The continuation in a big way is probably no. I mean, we are going to be careful for the next property that we start. But I think there’s a few positive signs out there, one is the proposed changes in Ontario that the Ford government is basically done or will do.
They are going to basically reduce a lot of the cost and I think it’s going to be cheaper from a development point of view, from a land dedication, so there’s quite a few positive things there and I think that will help start to sort of bring back the costing of these developments.
And I think there’s opportunities from looking at developments with an affordability factor to it and there’s lots of talk about increased government programs to help offset the overall cost for new product, which is pretty exciting.
And then, at the same time, there still is, from our point of view, opportunity to see risk rising in new developments and so if you go in the ground, thinking your pro forma is $3, there’s a good chance in two and a half year’s time, it’s going to be higher. The issue today is availability of capital and what you are going to and where you put your capital.
Mark Rothschild
Okay. Great. And maybe just one more question, when we look at the cost of debt, would it be similar to the rates you received in the quarter on new debt or has it moved further?
Philip Fraser
Sorry. What was you are asking…
Dale Noseworthy
Cost of debt, that was…
Mark Rothschild
And interest rates on new mortgages as you refinance debt.
Dale Noseworthy
Oh!
Philip Fraser
I mean the rates are moving as the bond yields move, right, Mark? So it’s what we are doing at the beginning of the quarter is cheaper than what we are doing today, so.
Dale Noseworthy
But we are looking at probably CMHC Insured probably between 4.5% and 4.8% not much difference than 5% and 10%, but it’s changing around by lender and by day.
Mark Rothschild
Okay. Great. That’s helpful. Thanks.
Philip Fraser
Thank you.
Operator
Your next question comes from the line of Matt Kornack from National Bank Financial. Your line is open.
Matt Kornack
Hey, guys. Just a quick follow-up with regards to, I mean, you mentioned the cost and availability of financing with regards to development. Are you expecting, I mean, notwithstanding your pipeline, but others in the market to potentially put projects on hold and then we will have an issue of less supply as we are seeing some of this population growth across the country?
Philip Fraser
I hope not. But and then the reality is, I really don’t know. I mean, you kind of start to hear. But I think the lenders that we have in Canada are very good. They understand risk. They understand exposure. And basically, the other thing that’s given is that in a rising interest rate environment, the cost of debt is going to be more, which means that there’s going to be probably more equity put into projects. So it depends on the — these individuals and private companies or other sort of entities out there. But the other thing is that there’s a lot of money still out there in the system.
Matt Kornack
Fair enough. That makes sense. And then for you guys, I mean, Eventide and Aurora, those — that project once it achieves final planning, I mean, I assume it’s of a size that you would be willing to go ahead with it whenever you can start it in 2023, is that a fair comment?
Philip Fraser
Well, I mean, if this was last year, I would have been saying, I think, we are expecting to get the actual permit any day and here it is another year that’s gone by and we don’t have the permit. So that will be a decision once we actually get it in our hands.
Matt Kornack
Okay. That makes sense. And then just on Jonathan’s earlier question with regards to the 600 suite renovations. I think the opportunity is 5,500, but that ultimately depends on, I guess, what suites turnover. I guess do you see kind of 10% a year of that figure that would be suitable type suites to renovate and reposition?
Dale Noseworthy
10% of our turnover?
Matt Kornack
Of the 5,500 opportunity?
Dale Noseworthy
Oh!
Robert Richardson
yeah. That’s a fair number.
Dale Noseworthy
Yeah.
Matt Kornack
Fair enough. Thanks.
Robert Richardson
It’s in the…
Matt Kornack
I just was wondering, because I don’t know what the nature is in terms of the suites that are, do those tend to be longer existing leases that are the opportunity or are you seeing it in shorter duration leases as well unfortunately?
Dale Noseworthy
We still have an opportunity in shorter duration, because when you look at, we have been at this for about four years, five years we have ramped it up. So there’s still lots of opportunity across the portfolio.
Matt Kornack
Okay. Fair enough. Thank you.
Operator
[Operator Instructions] Your next question comes from Johann Rodrigues from Industrial Alliance. Your line is open.
Johann Rodrigues
Hi, guys.
Philip Fraser
Hi.
Johann Rodrigues
Expense inflation, obviously, it hit almost every market, but New Brunswick has seem the expenses held fairly in check and Moncton didn’t had that property tax reversal, but even the other two cities and even St. John’s and Newfoundland has seen pretty minimal expense growth, not just this quarter but kind of a couple of quarters running now. What is it about those markets that are kind of keeping it in check, is it just cheaper utilities or anything beyond that?
Dale Noseworthy
In Newfoundland, it certainly it’s all electricity. So you don’t have the exposure to natural gas. New Brunswick, it was mainly driven by the property tax, the reduced property tax across all of the regions there.
Johann Rodrigues
So it’s more than just Moncton, okay.
Dale Noseworthy
It wasn’t just Moncton, it was all of them.
Johann Rodrigues
Okay. And then second question, you put in there a target, 40% target for NOI generated outside Ontario by 2025. How would you say that split between Ontario versus Western Canada?
Philip Fraser
So I think we are looking at a big picture, so it’s combined. I mean depending on how things go over the next couple of years. We are big believers of the West, especially Alberta in the last year or so with the resurgence of oil. That’s a pretty vibrant market right now. And BC has been very good to us so far and plus we have got a great base in Ontario with a lot of upside, so…
Dale Noseworthy
Even the developments we have just completed and going to be completed in Ontario, those alone are going to help us. In the shorter term, Ontario looking forward for next year should grow just based on the lease-up of those developments alone.
Johann Rodrigues
Okay. Thanks.
Philip Fraser
Thank you.
Operator
There are no further questions at this time. I will turn the call back to Mr. Fraser for closing remarks.
Philip Fraser
Thank you for participating today and we look forward to reporting Q4 2022 next February. Thank you.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you disconnect your lines.
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