Morguard North American Residential Real Estate Investment Trust (OTC:MNARF) Q3 2022 Results Conference Call October 27, 2022 3:00 PM ET
Company Participants
Paul Miatello – SVP
Rai Sahi – Chairman and CEO
Angela Sahi – EVP, Canada
Chris Newman – CFO
John Talano – SVP, U.S.
Patrick Seward – VP, Corporate Development
Beverley Flynn – SVP, General Counsel
Conference Call Participants
Jonathan Kelcher – TD Securities
Jimmy Shan – RBC Capital Markets
Operator
Good afternoon, ladies and gentlemen, and welcome to Morguard North American Residential REIT Third Quarter Conference Call. [Operator Instructions] This call is being recorded on Thursday, October 27, 2022.
I would now like to turn the conference over to Paul Miatello. Please go ahead.
Paul Miatello
Thank you, operator. Thank you, and good afternoon, everybody, on the call. Thanks for joining us this afternoon for the REIT’s third quarter results conference call. With us on the call today, we’ve got Rai Sahi, Chairman and Chief Executive Officer; myself, Paul Miatello. I’m the Senior Vice President. We have Angela Sahi, Executive Vice President in charge of Canadian Operations; Chris Newman, our Chief Financial Officer; John Talano, Senior Vice President of U.S. Operations; Patrick Seward, Vice President, Corporate Development; and Beverley Flynn, Senior Vice President, General Counsel.
So, we’ve had a very positive third quarter for the REIT, and there’s a number of highlights. So I’m going to turn it over to Chris Newman, our CFO, now for some comments, and then we’ll open the floor for some questions. So, Chris, go ahead.
Chris Newman
Thank you, Paul. As is customary, I’ll provide some comments on the REIT’s financial performance and financial position. So in terms of our financial position, the REIT completed the third quarter of 2022 with total assets amounting to $4.2 billion, higher compared to $3.5 billion at December 31, 2021, resulting from a fair value increase on the REIT’s income-producing properties of approximately [ $410 million ]. The value increase is a result of cap rate compression realized on most of our U.S. portfolio during the first quarter as well as increases in underwritten NOI in both the U.S. and Canadian properties supported by strong rent growth. During the third quarter, the REIT completed the following transactions. On August 24, the REIT sold its property located in Slidell, Louisiana, comprising 144 suites for net proceeds of USD 17.6 million after closing costs and the repayment of mortgages payable secured by the property. On August 8, the REIT acquired Echelon Chicago, a multi-suite residential property comprising 350 suites located in Chicago for a purchase price of USD 135.6 million including closing costs and was partially funded by a mortgage in the amount of USD 74.7 million at an interest rate of 4.71% and for a term of 7 years.
On September 26, the REIT acquired Rockville Town Square, a retail property, comprising approximately 187 square feet of commercial area located in Rockville, Maryland, for a purchase price of USD 33.8 million, including closing costs. Rockville Town Square is a part of a mixed-use complex, where the REIT currently owns a 50% interest in the residential property, the Fenestra apartments, through a joint venture with Morguard Corporation. And subsequent to quarter end, the REIT sold its property located in Coconut Creek, Florida comprising 340 suites for net proceeds of USD 71.6 million after closing costs and the repayment of mortgages secured by the property. The REIT’s disposition of 3 assets this year supports management’s strategy to dispose of assets where values are benefiting from strong market demand and to focus on opportunities to acquire properties located in urban centers and major suburban markets in Canada and the U.S. To add, the REIT utilized the tax-deferred strategy under Internal Revenue Code Section 1031 in connection with its U.S. property dispositions and is pursuing a 1031 exchange on the REIT’s recent disposition completed subsequent to quarter end. Under a 1031 exchange, subject to certain conditions, the REIT will be able to defer tax payable upon the acquisition of a replacement property.
The REIT finished the third quarter with $23 million of cash on hand and $76 million advanced to Morguard Corporation under its $100 million revolving credit facility, which provides the REIT with $176 million of availability under the facility. In addition, subsequent to quarter end, the REIT has approximately USD 70 million from the net proceeds on the disposition of the property located in Coconut Creek, Florida. The REIT completed the third quarter with $1.3 billion of long-term debt obligations. And on July 1, the REIT completed the refinance of a property located in Palm Beach County, Florida, at an interest rate of 4.19% for a term of 10 years, providing additional net proceeds of USD 23 million. And as at September 30, 2022, the REIT’s overall weighted average term to maturity was 4.9 years, a decrease from 5 years at December 31, ’21, and the weighted average interest rate increased to 3.45% from 3.31% at December 31, 2021.
REIT’s gross — the REIT’s debt to gross book value ratio improved to 36.7% at September 30, 2022, down compared to 40.2% since December 31, 2021. Turning to the statement of income. Net income was $81.2 million for the 3 months ended September 30, 2022, compared to $86.7 million in 2021. The $5.5 million decrease in net income was primarily due to a lower fair value gain on real estate properties of [ $48.7 million ] relative to the gain recorded during 2021 and was partially offset by a higher fair value gain on Class B LP units of $22.7 million, reflecting a decrease in the REIT’s unit price during the third quarter and was also offset by an increase in NOI of $7.7 million. IFRS net operating income was $44.9 million for the third quarter of 2022, an increase of $7.7 million or 20.8% compared to 2021.
The change in foreign exchange — in the foreign exchange rate increased NOI by $1.9 million of the overall $7.7 million variance to last year.
And on a same-property proportionate basis, NOI in the U.S. increased by USD 3 million or 20% as an increase in revenue from AMR growth net of higher vacancy and an increase in ancillary revenue was partially offset by an increase in operating expenses. NOI in Canada increased by $1.3 million or 10.5%, mainly due to AMR growth and lower vacancy, partly offset by an increase in operating expenses. And the change in foreign exchange increased NOI by $1.6 million.
Interest expense increased by $0.7 million for the third quarter of 2022 compared to 2021 primarily due to an increase in interest on mortgages of $1.4 million, mainly resulting from additional net mortgage proceeds on the completion of the REIT’s refinancings during 2022 and during the fourth quarter of 2021 as well as a net increase from the impact of acquisition and dispositions as well was partially offset by a higher noncash fair value gain on the convertible debentures’ conversion option of $6 million.
The REIT’s third quarter performance translated into basic FFO of $21.1 million, an increase of $5 million or 30.9% when compared to 2021. And on a per unit basis, FFO was a record high at $0.38 per unit for the 3 months ended September 30, 2022, an increase of $0.09 compared to $0.29 per unit in 2021. The increase in FFO per unit was due to the following: on a same-property proportionate basis in local currency, an increase in NOI from higher AMR and lower vacancy partly offset by an increase in interest expense and trust expenses had a $0.04 per unit positive impact. And a change in the foreign exchange rate had a $0.02 per unit positive impact. Also an increase from the contribution of the REIT’s development property, which reached stabilization in October 2021, had a $0.01 per unit positive impact.
And an increase in other income, primarily from an increase in interest income on the Morguard facility, had a $0.02 per unit positive impact. The REIT’s FFO payout ratio continued to decline to 46.6% for the 3 months ended September 30, 2022, a very conservative level, which allows for significant cash retention. In addition, the REIT is pleased to announce an increase in annual cash distribution of $0.02 per unit, an increase of 2.86%. This will bring the distribution to $0.72 per unit on an annualized basis from the current level of $0.70 per unit. Operationally, the REIT’s average monthly rent in Canada increased to $1,573 or 2.8% compared to 2021, reflecting the quality of our Canadian portfolio.
And during the third quarter, the Canadian portfolio turned over 15.4% of total suites and achieved 12.6% AMR growth on suite turnover. While in the U.S., same-property AMR increased by 13.8% compared to 2021, having an average monthly rent of USD 1,704 at the end of September 2022, as the REIT continued its strong performance, benefiting from strong market fundamentals across the regions.
The REIT’s occupancy in Canada finished the third quarter of 2022 at 98.3% compared to 92.7% at September 30, 2021. Overall, occupancy has increased across the portfolio as leasing activity increased to pre-pandemic levels as economic conditions improved and as people returned to their normal routine. Same-property occupancy in the U.S. of 95.8% at September 30, 2022, was slightly lower compared to 96.3% at September 30, 2021, as U.S. occupancy is still maintaining optimum levels.
And during the 9 months ended September 30, 2022, the REIT’s total CapEx amounted to $22.9 million. That included revenue-enhancing in-suite improvements, common area and exterior building additions as well as we continued to ensure that we maintain the structural and overall safety of our properties. And the REIT’s collection of rental income during the 9 months ended September 30, 2022, continues to be materially in line with historical collection rates.
At this time, I’ll turn the call back over to the moderator to open up the line for questions.
Question-and-Answer Session
Operator
[Operator Instructions] We’ll take our question from Jonathan Kelcher with TD Securities.
Jonathan Kelcher
First question, just on the rent growth that you’re seeing in the U.S., we’re seeing more reports of monthly rents kind of stalling out. And I just want to get your view on what you’re seeing and what you expect over the next couple of months.
Chris Newman
Jon, we’ll pass it over to John Talano in the U.S. to answer that question on the U.S. operations.
John Talano
Sure. I would say we are definitely seeing a slowing of our increases in market rates on new leases. And that’s, generally, it just depends on the market. We still are getting increases. We have a significant buffer between our scheduled rents, the in-place rents and where market rents are today. So that is about a $250 difference. So there’s definitely some room there. But overall, we see it slowing. We don’t see — we haven’t seen a stall. But also going into the winter months, those do happen in our northern markets anyway seasonally, so I wouldn’t say it’s super concerning currently.
Jonathan Kelcher
Okay. Do you see yourselves trying to push occupancy up heading into the winter months?
John Talano
We do that on an individual property basis with our revenue management system. So yes, we take the pressure off some of the rental increases in the colder markets depending on which renewals are up when. But we generally have a lower turnover during the winter months as well, which is designed, right? We actually do that through the revenue management system so that we have more of our leases expiring over the summer months when our folks are moving.
Jonathan Kelcher
Okay. That’s helpful. And then just secondly on the 1031, the proceeds, how — like can you just let us know how much you need to spend? And are there any markets that you’re looking at in particular?
Chris Newman
Yes, the amount of equity we still need to put to work is, call it, in and around $60 million to $65 million to be fully sheltered from tax. So the rules are complicated, but at a general level, that’s what we need to do.
Jonathan Kelcher
U.S., correct?
Chris Newman
U.S., that’s U.S. dollars, yes. I’m sorry, Jon, the second part of your question was?
Jonathan Kelcher
Are there any particular markets that you’re looking at?
Chris Newman
Markets, yes, we’re looking at basically sticking to our existing footprint for the most part, not to say that we wouldn’t look at others, but we are tending to look more favorably at our existing footprint. So everything in the U.S. that we’re in now, it’s open season on those markets.
Operator
[Operator Instructions] Next we’ll go to Jimmy Shan with RBC Capital Markets.
Jimmy Shan
Just in terms of deploying that $65 million — $60 million, $65 million, so what are you seeing in terms of pricing? Because it sounds like there’s very limited volume, very limited listings. So just kind of how are you thinking about underwriting assets in this kind of environment?
Paul Miatello
Yes, Jimmy, it’s Paul. I’ll start with a couple of comments. Then I’ll turn it over. But generally, the transaction market has definitely slowed. The bidding pool has shallowed. We just went through all these dispositions. And when we sold the first one, Atlanta, we had 100 confidentiality agreements signed, and then as the interest rates went up, interest declined. So obviously, it makes sense with where we are in the interest rate cycle. So the bidding pool is definitely more shallow. The pricing is different, I would say, depending on the market.
Like if you’re still in these primary markets where you’re still seeing quite a bit of rent growth, there are bidders showing up and pricing probably hasn’t really changed that much, pricing might be off 5% to 10% maybe depending on the market, but you’re not seeing a whole lot of distress. And again, that’s all sort of — the overarching comment is that the transaction velocity is well down. Maybe I’ll turn it over to John or Patrick if they have any further comments.
Patrick Seward
Jon (sic) [ Jimmy ], Patrick here. I mean Paul’s comments are completely accurate and relevant. Access, deal reputation and creativity always puts us on the top of everybody’s mind. So we have all sorts of things going on. Some of them relevant, some of them aren’t, but a lot of it, we can’t share in this call. But we pour it all into the mix, and we try to figure out what’s best for the shareholders.
Jimmy Shan
So we’re hearing a lot about asset transactions that are getting done today in the U.S., as you mentioned, the ones in the major markets, as you mentioned, are being done at negative leverage. Is that how you’re thinking in deploying that $60 million, is going to have to look like?
Patrick Seward
I mean the short answer to that, for 70% of the things on our desks, is yes. That is economics 101 unfortunately, but that’s the Fed. We think that’s not a long-term phenomenon. And as much as cap rates, we’re focused on quality of assets. I think that’s really what Echelon is all about and the 1031 exchange program is all about, quality of asset, quality of return, consistency and growth, blah, blah, blah That’s it.
Paul Miatello
Yes. And just to add to the math around the trades that we’re doing, I mean, we’re selling assets in the Southeast at 3 caps and 3.25 caps on trailing income, so we’re having good — really good opportunities to redeploy those capital very accretively. And like Patrick said, we’re thinking very long term with the assets. Financings come and go, but yes, for the — certainly, for the time being, there is some negative leverage for sure.
Jimmy Shan
Okay. And you have until when to deploy that for the end of the year?
Paul Miatello
180 days from October 6, which was the day of disposition of Blue Isle.
John Talano
The only thing that I would add — this is John Talano — is that we are seeing a lot more off-market deals as well. So there is a lot of activity, and there’s a lot of folks that are calling us, which we didn’t have before. So I would say, from that perspective, we have much more to choose from for sure.
Jimmy Shan
Right. And just so I understand the kind of the cap rate range we’re talking about here, so for the Atlanta as an example, like what would the cap rate look like in today? When you say it’s down maybe 10%, maybe 15% or 5% to 10%, as you said, is it — are we talking about mid-4 caps, 5 cap? What’s the ballpark?
Paul Miatello
Patrick, do you want to — sorry, John, go ahead. You start.
John Talano
In Atlanta, we were recently looking at product that was closer to a 5 cap. And those values were actually — for new product, were actually lower than what we sold our mid-1980s vintage for.
Patrick Seward
So only just to repeat, and we have to emphasize, though, that Paul’s original issue that we take everything individually, and every situation is different, is very important, looking at affordability, where rents are, where they could be moved, John’s management systems, where there’s excessive risk, we need be rewarded. So yields are up, but it depends.
John Talano
Yes, our focus is definitely quality of asset and location.
Jimmy Shan
And then just a quick follow-up on the — you had mentioned on the slowing of increases in the U.S., but you’re still seeing increases in [ Mid East ]. What is it slowing to roughly?
John Talano
It depends — I mean, it completely depends on the market. And I would say it’s going to more normal increases. We saw rates of 3% to 5% in previous years. But again, a lot of our AMR growth will be tied to the difference between what is in place today and what is — and what market is. So there’s a $250-ish difference across the portfolio today just in the residence we do have.
Operator
[Operator Instructions] And I show we have — actually, we do have a question. Next, we’ll go to [Hal Dash], private investor.
Unidentified Analyst
I just got a quick general question. It sounds like you’re moving from the Southeast to the Northeast as far as your purchases and sales. And I’m wondering what the rationale is for that. And what percentage is in the Northeast versus the Southeast now?
Paul Miatello
Thanks for your question. Paul here. I mean there’s — yes, perhaps there’s maybe a bit of a shift. I mean, obviously, Chicago has become an important market for us over — that’s happened over many years. It has not happened recently. But we’re still looking to be very well diversified between Northeast, Southeast. So we don’t have any targets or allocations that I can speak to on this call. And to say — repeat something that’s been said a few times, we’re largely looking at the scale or on the scale of quality for these assets. So we’ve been able to achieve that in Chicago probably more recently, but we will maintain pretty disciplined balance. It’s not like we’re shifting all to the Northeast or anything like that. We’ll remain pretty disciplined and diversifying in terms of geographies.
Unidentified Analyst
So roughly what percentage is in North versus the Southeast now?
Paul Miatello
I don’t know that. Chris, do — can you comment?
Chris Newman
Yes. On the portfolio, including Canada, so it’s about 15% to 18% of suites and NOI is represented from the Northeast.
Operator
And we do have one. It looks like a follow-up from Jimmy Shan with RBC Capital Markets.
Jimmy Shan
Yes. Sorry, I was just going to follow up on Canada. And occupancy moved up a decent amount this quarter and wondering if you just could make some general comments on what you’re seeing in the GTA. And it seems like things have moved up quite a bit in the last couple of months in terms of market rent and even occupancy.
Chris Newman
No problem. Angela, do you mind that?
Angela Sahi
Sure. Yes. So across our portfolio on the GTA, we’ve actually — our occupancy is up significantly. Mississauga, we’re at 99% in occupancy already; and the Toronto portfolio, we’re almost at 98% or 98.6%. So by the end of the year, we’ll be approaching 100%.
Ottawa, for example, at 160 Chapel, we were at 79% at the end of last quarter, and we’re at 99.3% now. So we’ve seen a big recovery. A lot of it is just with [indiscernible] and turnover with students coming back in Ottawa. Edmonton is still a little bit of a challenge, but we’re approaching the low 90s now, and we do expect by the end of the year to hopefully be kind of mid-90s in occupancy. But GTA is looking really strong.
We have a couple of buildings that are 100% occupied in Mississauga. So the trend is definitely more positive. The demand is higher for rental products with what’s going on with interest rates in the housing market and obviously, the influx of immigration and just lack of housing supply. So we’re seeing lots going on as well compared to previous years. So I think that’s what we’re finding, and we’re able to increase rents pretty significantly on turnover as well.
Jimmy Shan
Right. And are you at a point where you’re increasing rents at about the same pace as you were pre-COVID?
Angela Sahi
Pre-COVID, definitely. Yes. Yes, maybe even a little bit more.
Operator
I’m showing we have no further questions. And I’ll turn the call back over to our speakers for any additional or closing remarks.
Paul Miatello
Okay. Thank you, operator, and thank you, everybody, for joining us today. We look forward to speaking to you at the next conference call. Thank you.
Operator
Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation. You may now disconnect your line.
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