BSR Real Estate Investment Trust (HOMUN) Earnings Call Transcript & Summary

Good day. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the BSR REIT Q2 2023 Financial Results Conference Call. [Operator Instructions] Mr. Oberste, you may begin your conference.

Thank you, Michelle, and good afternoon, everyone. Welcome to BSR REIT's conference call to discuss our financial results for the second quarter ending June 30, 2023. I'm joined on the call by Brandon Barger, our Chief Financial Officer; Susie Rosenbaum, our Chief Operating Officer is also with us and will be available to answer your questions following our prepared remarks. I'll begin the call with an overview of the quarter. Brandon will then review the financials in detail, and I'll conclude by discussing our business outlook. After that, we will be pleased to take your questions. To begin, I want to remind listeners that certain statements about future events made on this conference call are forward-looking in nature. Any such information is subject to risks, uncertainties and assumptions that could cause actual results to differ materially. Please refer to the cautionary statements on forward-looking information in our news release and MD&A dated August 9, 2023, for more information. During the call, we will reference certain non-GAAP financial measures. Although we believe these measures provide useful supplemental information about our financial performance, they're not recognized measures and do not have standardized meetings under IFRS. Please see our MD&A for additional information regarding our non-IFRS financial measures, including reconciliations to the nearest IFRS measures. Also, please note that all dollar amounts are denominated in U.S. currency. We delivered another quarter of stellar financial performance in Q2. It was highlighted by Same Community revenue growth of 8.5% and Same Community NOI growth of 11.7% compared to Q2 last year. FFO and AFFO increased by 14.1% and 10%, respectively, compared to Q2 2022. The results reflect the continued strong fundamentals of our 3 core Texas markets where rents are increasing at a solid pace and occupancy levels remain very high. FFO and AFFO were also boosted by our previous interest rate swaps, which reduced the negative impact of high interest rates. Our weighted average rent at the end of June 2023 was $1,501 per apartment unit, representing a year-over-year increase of 6.3%. During the quarter, rental rates for new leases and renewals increased 1.1% and 6.7%, respectively, over the prior leases, resulting in a blended increase of 3.7%. Weighted average occupancy at quarter end was 95.3%, a slight increase from 95% a year earlier. During the second quarter, we repurchased and canceled more than 390,000 units under our NCIB in our automatic shares purchase plan at an average price of $12.43 per unit. That brought our total repurchases in the first half of the year to nearly 1.5 million units at an average price of $13.25. As long as our units trade at a significant discount to NAV, we see buybacks as an attractive option. We will continue to capitalize on opportunities to repurchase REIT units to drive stronger financial returns. I'm also pleased to note that with inflation moderating and cap rates stabilizing, we expect to see more external growth opportunities emerge in the coming months. I will speak more about this later on the call. Given the continued strength of our rental markets, our high-quality portfolio and our excellent operating performance, we are maintaining the positive financial guidance for 2023 that we first announced in March. So our business outlook remains very strong for the second half of the year. I'll now invite Brandon to review our second quarter financial results in more detail. Brandon?

Thanks, Dan. Same Community revenue increased 8.5% in the second quarter to $40 million compared to $36.9 million in Q2 last year. The improvement primarily reflected a 6.5% increase in average rental rates for the Same Community properties from $1,403 per apartment unit as of June 30, 2022, to $1,495 as of June 30, 2023. Total portfolio revenue for Q2 2023 increased 8.4% to $42 million compared to $38.8 million in Q2 last year. This reflected $3.1 million of organic Same Community rental growth and a contribution of $0.1 million from non-stabilized properties. NOI after the Same Community properties was $22 million, an increase of 11.7% from $19.7 million last year. The increase reflected higher Same Community revenue partially offset by an increase in property operating expenses of $0.8 million due to higher payroll costs and property insurance. NOI for the total portfolio increased 9.7% to $23 million from $21 million in Q2 last year. Same Community NOI growth boosted total NOI by $2.3 million, partially offset by a reduction of $0.3 million from property dispositions. FFO for Q2 2023 increased 14.1% to $13.3 million or $0.23 per unit compared to $11.6 million or $0.21 per unit last year. The increase reflected the higher NOI, partially offset by a $0.2 million increase in finance costs and a $0.2 million increase in G&A expenses. AFFO increased 10% to $11.5 million in Q2 2023 or $0.20 per unit from $10.5 million or $0.19 per unit last year. The increase was primarily due to the higher FFO, partially offset by higher maintenance capital expenditures due to the timing of projects in the quarter at 2 specific properties. I wanted to note that we generated finance income in Q2 2023 of $3.2 million, primarily from our recent interest rate swaps. That income offset most of the year-over-year increase in finance costs related to higher interest rates, which positively impacted FFO and AFFO. The repaid quarterly cash distributions of [ $0.1299 ] per unit in Q2 this year and last year, representing an AFFO payout ratio of 63.9% in Q2 of 2023 and 71.8% in Q2 2022. All distributions were classified as a return of capital. Turning to our balance sheet. The REIT's debt to gross book value as of June 30, 2023, was 39.4% or 37.3% excluding the convertible debentures. Total liquidity was $189.9 million, including cash and cash equivalents of $6.3 million and $183.6 million available under our revolving credit facility. We also have the ability to obtain additional liquidity by adding properties to the current borrowing base of our credit facility. As of June 30, we had total mortgage notes payable of $498.2 million with a weighted average contractual interest rate of 3.3% and a weighted average term to maturity of 4.2 years. Those figures exclude the credit facility and a construction loan for a property under development. Total loans and borrowings at quarter end were $746.2 million with a weighted average contractual interest rate of 3.3%, excluding the debentures and the construction loan, and 97% of our debt was fixed or economically hedged to fixed rates. The outstanding convertible debentures were valued at $41.8 million as of June 30 at a contractual interest rate of 5%, which mature on September 30, 2025, with a conversion price of $14.40 per unit. Our high percentage of fixed rate debt at quarter end is partially due to the recent interest rate swaps, which have materially reduced our interest rate exposure. In May of this year, we entered into a new $50 million interest rate swap at a fixed rate of 2.25%. This swap takes effect on October 1, 2024 and matures on July 1, 2031, subject to the counterparty's optional early termination date of February 1, 2027. Finally, I want to note that in June, we exercised our option to extend the maturity of our revolving credit facility by a 12-month period. It now matures on September 30, 2026. I will now turn it back over to Dan for some closing comments. Dan?

Thanks, Brandon. BSR REIT has clearly established a track record of very strong financial performance with consistent growth across all of our key metrics. We are confident that this will continue for the foreseeable future. It is supported by very strong fundamentals in our core Texas markets. Job growth and population growth in the Texas Triangle continue to outpace the national average, and rental housing remains highly affordable compared to major gateway cities, even after significant rent increases over the last couple of years. Annual rent as a percentage of income in our core markets is less than 25% compared to the national U.S. average of 35.3%. We are maintaining the financial guidance for 2023 that we first announced in March. It calls for FFO per unit of $0.90 to $0.96 compared to $0.86 last year, AFFO per unit of $0.83 to $0.89 compared to $0.80 last year, Same Community revenue growth of 5% to 7%, Same Community NOI growth of 6% to 8% and growth in property operating expenses of 4% to 6%, below the projected growth in revenue and NOI. Last month, the Texas House and Senate agreed to lower real estate taxes, including for multi-family residential rental properties. A constitutional election is expected to be held on November 7th. If the measure is passed, the decrease in taxes will apply to the 2023 tax year. We estimate that it would create annualized tax savings for BSR of approximately $1.3 million to $1.5 million. We have excluded this from our guidance since it is not yet ratified, but it would be a meaningful and welcome development. Our guidance also does not take into account any potential acquisitions. As you are aware, our M&A activity has slowed down in the rising interest rate environment. Investor demand for high-quality, well-located properties in our core markets has been high. And as a result, cap rates have not risen in line with interest rates. Fortunately, inflation appears to be moderating, and we expect more acquisition opportunities to emerge in the coming months. With our strong liquidity position and prudent debt profile, we are well positioned to capitalize on these opportunities. As always, we are disciplined buyers and are focused on growing cash flow per unit. As depicted by another strong quarter, we are confident that we're on the right track. With our high-quality portfolio and high-growth markets and our outstanding team, we remain well positioned to drive strong returns for our unitholders. That concludes our remarks this morning. Brandon, Susie and I would now be pleased to answer any questions you may have. Michelle, please open up the line for questions.

[Operator Instructions] The first question comes from Mike Markidis of BMO Capital Markets.

Dan, I just wanted to touch on your comments with respect to the Fed, I guess, being near the end of its rate hike cycle and how that creates more acquisition opportunities to you. Is that based on just certainty in the market and being more confident? Is it based on rates coming down? Like how should we be thinking about your increased enthusiasm there?

Sure, and I'd tell you what, I started off, Mike, if I knew whether rates are going to be up or down in the future, I'd be sitting underneath the shade tree right now betting on interest rates. I don't think it's our view that we think rates are going to come down. What we believe is that we're entering into a period of stabilization. So as a reaction to the central bank's moves, the yield curve has become increasingly volatile, and that's created opportunities for us to finance through the use of hedges and swaps that the investors have seen over the last year. On a look forward, I think the consensus is reflected by the yield curve, creates a bit more stability in the cost of time or interest. And as a result, more and more potential buyers are able to finance at a rate constant void of volatility. And as more and more investors are able to finance at a rate constant, they're able to assign an appropriate spread on top of that financing cost in order to acquire an asset at a cap rate. So that's the, I think, dynamic we think start to take place beginning in May on the street. It's our view that investors are willing to accept a lower spread between BBB bonds or between the 10-year and an unlevered -- and a cap rate in our markets. And so that kind of opens up external growth a little bit more than it has been over the course of the last 18 months.

Okay. So increased buyer confidence, not really seeing -- it sounds like not really seeing much. I mean I know your cap rates came up a little bit, but the cap rates you're seeing still, the spread is still negative on a year 1 basis to your financing costs?

I think if you're financing using floating rate debt right now, you're going to finance in the mid-6s or mid-7s. I think what we're seeing in the U.S., the majority of those -- of the apartment acquirers -- are going to use Fannie Mae, Freddie Mac, HUD, fixed rate debt options for their acquisitions. So yes, we're probably seeing a little bit of a negative return year 1 as cap rates at 4.70% or well below the 6% to 7% floating rates. I think what we're seeing, it's compelling is that the fixed rates are actually kind of lower than the floating rates right now. And with continued rent growth and kind of stabilizing operating metrics, an underwriter, an acquirer can underwrite to an appropriate cap rate and a lower handle on their interest carried.

Okay. And if you take the optimistic view, the equity markets adjust to reflect this dynamic and your stock price increases. But pardon me, if that isn't the case, are you prepared to take leverage up on the balance sheet?

That's a great question. We have always made decisions in this business with an eye towards growing cash flow per unit, whether it's FFO, AFFO or just other metrics, true cash flow per unit. If we see an opportunity to use leverage and to create a profit for our investors and increase the cash flow per unit for our investors by acquiring, we'll certainly lever up the balance sheet to do so.

Okay. Fair enough. And last one for me before I turn it back. I mean I guess you guys have -- it's been maybe 3 quarters now that you've been highlighting the short-term leases as being, I guess, a small but a factor in terms of how AMR growth trends and where your actual leasing spreads come on the longer tenured leases. At what point does that go away? Or is there always going to be a shorter-term component to your portfolio?

Mike, there's always going to be a shorter-term component there because people are willing to pay more for those leases than the longer-term ones, but they're not very large. Right now, it's under 5% of total leases outstanding. And that's down significantly from where we were at year-end, which was around 9%, but I think it was right at 5% last quarter as well.

The next question comes from Sairam Srinivas of Cormark Securities.

Just looking at the rental spreads coming into this quarter, once again, I think there's some recovery in new leasing. But looking ahead, how should we be thinking about new leasing versus renewal spreads? And how would your current market trends -- how would the current market trends look to [ NCIB ]?

First, I'll speak to the spread. In July, they're still right in line with what we reported for the second quarter. They were up a little bit on the new leases at 1.4%. The renewals are at 5.5%. So that gives us a blend of 3.6%. And I think that it may come down just a tad, but it will still be in the 3s for the latter half of the year, which is well within our range of guidance. Regarding the mark-to-market, it -- right now, I see that at 7%. And that also fits right in, when you think it takes about 24 months to recognize mark-to-market, understanding that that's just a point in time and it can change every day. But that also fits in with a 3.5% increase for the remainder of this year and then bleeding into next year as well before you consider any organic growth.

Right. And the 3.5% you mentioned is overall, right?

I'm sorry?

The 3.5% spread that you mentioned for the rest of the year is basically both renewals as well as new leasing?

That's blended. Yes, that's right.

Okay. All right. And so, if you look at the 7% mark-to-market, how does that compare to, let's say, last quarter or even last year?

So it's shrinking, as I said it was last quarter. Last quarter, we were at around 10%. And at the end of the year, it was closer to 12%.

The next question comes from Matt Kornack of National Bank Financial.

Just with regards to the interest swaps that you've been doing and just your interest rate exposure generally, you have no payments this year. But is there interest rate exposure on the $160 million in 2024? Or has that been dealt with the swap arrangements that we've been seeing coming through?

Matt, it's Brandon. That's a good question. We actually have a 1-year extension option built in on that $160 million, which is maturing in 2024. So, we intend to exercise the 1-year extension option and push that out to mature in Q3 of 2025. So, there's no exposure on that facility.

Okay. And then the rate, I guess, given what you've done is unchanged then on that for the 1-year extension?

Correct.

And then maybe, Dan, you mentioned cost financing on variable rate, but where would a Fannie or Freddie sort of 5- and 10-year rate be at this point?

It's a volatile market, but it's stabilizing. I think Freddie offers attractive rates on 7, 10, 15 and 30-year options. So probably, say, mid- to high-5s right now.

Okay. And then I guess we're waiting for an inflection point at some point on the leasing front. You mentioned the mark-to-market is coming down, Susie, but I think there's a view that as supply deliveries come on and the pipeline gets trimmed down that we will see those mark-to-market maybe then expand again. Any comfort or guidance as to when you think that ultimately happens? And maybe then as a corollary to that, just from an economy standpoint, is there any sense that there are pressures building in any of the markets that you're in, in Texas? It seems like the U.S. economy is pretty strong at this point and the labor markets are still quite tight.

First of all, the deliveries to date have not impacted BSR materially as depicted by our numbers year-to-date. They really haven't impacted any other U.S. REIT who owns properties in high growing, high supply markets. So we haven't experienced any impact to date of the supply that's come in. Houston looks to perform and really outperform in this market as we've discussed for the last couple of years. It's not surprising us. Dallas continues to absorb the supply that's coming in even at the elevated tones that it looks to come in over the course of say the next 12 to 15 months. Austin, in particular, is a popular topic as it relates to supply. So what I would say is the supply that's been delivered -- well, let's back up. This time last year, we were all talking about or everybody was telling me about 30,000 units that were set to be delivered in Austin in 2023. So year-to-date, we've seen 6,000 of those potential 30,000 units be delivered. I've recently seen CoStar, MSCI and RealPage handful of other aggregators reducing their supply deliveries for '23 in Austin, down from 30,000 to 22,000. We think 22,000 is a bit high. But with that said, I do see about 50,000 units in the Austin pipeline. I think that it's our belief that a handful of those units or a material percentage of those units are on indefinite and forever holds. And -- but let's pretend that 50,000 -- we see 50,000 units delivered in Austin. We would think to the extent those are delivered, they're delivered over a 2 to 4-year period. Out of those deliveries, we have 3 properties in the north and central submarkets in Austin. Those markets are Cedar Park, Round Rock and Georgetown. Our properties are somewhat insulated as we discussed last quarter, given that our rents per unit on those apartments are about, I'll call it, about 25% below the cost of new rents or the new rents we're seeing on existing deliveries. With that said, we would expect some elevated supply to impact one or 2 or 3 of those properties over the course of the next 12 months. We'll continue to surveil those 3 properties. But outside of that, we really don't see supply impacting any other property in our portfolio. From an economic standpoint, Matt, Houston, Austin and Dallas continue, I would say we've seen they continue to lead the nation in net migration as a trifecta and a triangle. This is not uncommon. It's been the case for the last 20 years. They continue to outperform and they continue to produce outsized job growth. And we really -- we don't see anything new to cause us to deviate our opinion that those 3 markets in combination are the 3 strongest economic MSA -- economic drivers in the country. A huge asset to Texas and a fantastic asset to multifamily owners in those markets, including our investors.

Makes sense. And then maybe just briefly, I know you're not a developer per se, but it's an important point from a replacement cost standpoint. Like has the cost to build come down at all? I assume not inflation is still -- it's coming down, but not low. But just from a supply standpoint and the rents needed to build at this point relative to in-place rents in your portfolio?

Matt, we are a builder. We announced a development in Austin in 2021 at a cost of about -- I want to say about $230,000, $240,000 a suite is the gross net builder cost. We expect that project to be delivered probably towards the end of this year, conducting lease-ups and be in a stabilized position in, call it, the second or the third quarter of 2024. It's our view that construction costs and interest carry have continued to somewhat increase. So we've seen labor and materials cost pull back slightly on new developments. Land, we see land cost reductions of about 10% to 15% across the board in markets. But the land costs really didn't move in the needle for the developers. So all in, I think if we wanted to put the shovel in the ground right now in Texas, it would probably cost us about $250,000 to $275,000 a suite to build a comparable product to BSR. I think it would probably cost around $350,000 to $400,000 to build a mid-rise and upwards into $0.5 million a unit to build a high-rise apartment. Those numbers really haven't changed materially since 2021 or 2022. And I would say those numbers still compare pretty favorably to the price we bought at. We bought this portfolio at into about $170,000 a suite that our stock price implies our current units are valued at.

No, that's a glaring gap. And then, I guess, very last question here, I apologize. But I assume in terms of growth going forward outside of that development property, you'd be buying stabilized assets development is in the way forward in terms of growth profile for the REIT?

Our view is that we have capacity for roughly $300 million in acquisitions while preserving a conservatively leveraged balance sheet, Matt. So, with a slight uptick in cap rates that's been depicted this past quarter, combined with a stabilizing yield curve, we're beginning to see sufficient spreads that enable the REIT to produce accretive investment returns for our shareholders. If those spreads continue to exist, I think they're most predominant, Matt, in the lease-up properties. I think stabilized is very difficult. As cap rates street spreads for stabilized assets are still well below our ability to generate accretive FFO and AFFO unit for our shareholders. I do think that the development deals remain the best deal in town right now. Because if you think about it, it takes about 2 years to build something and it looks like starts have peaked and have dropped 30%, 40% in our markets and other markets in May and June year-over-year. So this population growth continues as it has since before all of us were born. Then in 2025 and '26, there's simply not going to be available housing for people in our markets and other fast-growing markets to live in. So to the extent you may you take the risk and bet on development right now, probably going to end up being one heck of a return for yourself in '25, '26, '27. With that said, we do have a development in the pipe. It looks to be delivered this time next year. But we're going to focus on the single and the double of accretive growth in that lease-up option where we can work with our reputable developers that we've done multiple deals with and generate an outsized return relative to stabilized without taking the risk inherent in developing deep -- or spending that $300 million on developments.

The next question comes from Kyle Stanley of Desjardins.

Maybe just sticking with your kind of external growth and acquisitions just given all your commentary, how are you balancing the potential for initial kind of year 1 dilution just given where the financing costs are versus getting a high-quality asset at an attractive cost basis? And then Dan, you talked about it in the past, doing kind of your look back cap rates. How is that all playing into your external growth outlook right now?

Yes, sure. Let's start with the balancing act, Kyle. I'm a fan of Jay Parsons. I don't know if you are, but Jay Parson is a leading multifamily thinker in the housing space. And if you want to really learn about U.S. multi-family housing, you got to follow them on Twitter. And 2 things that Jay Parsons talks about that definitely correlate. The first is in supply heavy markets, you're going to have a little bit tougher time in the near term, generating rate growth in excess of those markets that are experiencing no supply. That's just kind of basic common sense stuff that makes sense. The second thing he talks about is real estate investors are not interested in buying and selling in a 1-year period. He says the total return directly correlates with supply heavy markets. Total return in supply heavy markets over the medium and long term is well in excess of those markets where no one is moving to, right? Makes sense. Supply heavy markets experienced population growth in housing deliveries. And these markets are always lower and they always lag housing formations. So in brief, you know you've struck gold in an investment when everyone else moves into your block. That's the first approach we take when we think about acquisitions. From a balancing act, we talked about it, I think I kind of addressed it from a different perspective in a recent question. From a balancing act, we constantly look at the risk premium involved in a lease up against a stabilized project. And as our investors have enjoyed, we have an internalized platform that's well experienced in leasing up properties. Right now, we see an excessive return in acquiring lease-ups, meaning the lease-up -- the purchase discount on lease-ups a little bit higher than it's been in the past. And we'd like to put our platform to work to generate outsized returns. So while I think that we've shown with our acquisition patterns that we're not going to be tolerant to deploy capital if on day 1 it's not accretive to our unitholders and a stabilized project, we'll continue that discipline. On a lease-up project, we think there's an outsized chance that it could be accretive on day 1 against our weighted average cost of capital and against our FFO and AFFO unit metrics. Does that address the questions you were asking about our views on the balancing act?

Yes. No, that's perfect. And I do follow Jay Parsons on Twitter. He's got a lot of interesting commentary. So I agree with you there. I'm just wondering, maybe taking all of your market commentary you've provided and you're reluctant to provide guidance too far out, and we still have the back half of this year, but I'm just wondering what is your expectation for same property revenue, same property NOI growth in the coming year, just given all of kind of the puts and takes we've discussed?

Susie, would you like to talk about the coming year? Meaning -- are you referring to 2024 call?

Yes, '24.

Well, I think it's probably a little bit too early in August for us to really provide some specific numbers on our expectations for revenues and expenses in '24. I do think with a moderating leasing or moderating interest rate environment, I think the concerns about buying out of cap being underwater to your debt costs probably are alleviated somewhat. And I would just encourage everyone to look at -- outside of BSR's numbers -- look at BSR's expected growth rates on weighted average by markets compared to every single one of our competitors in the sector, both in North America -- I mean, both in Canada and in the United States. And I think what the investor would find is if you waited what CoStar and a handful of other market, RealPage, Real Analytics, a handful of other market studies, market theologians on future rent growth and absorption, the way they view it is that the weighted average of Dallas, Houston, Austin, even adding in Oklahoma City and Little Rock, the weighted average organic increase that a portfolio sitting in those markets would experience is well in excess of the U.S. average multifamily expected increase for other -- for many other of our competitors. So whatever we do next year, without getting into what we specifically think this portfolio is going to do, whatever we do, we know we're situated in the right locations. And that those revenues that we generate, that we will generate are going to be in excess of comparable portfolio that's not situated in our markets.

The next question comes from Gaurav Mathur of iA Capital Markets.

Congrats on the strong performance this quarter, team. Just staying on the transactions market for a moment, could you potentially discuss what the seller profile looks like? And are you seeing more sellers come to market that may be distressed or under duress?

So the first, I think -- to answer your first question, Gaurav, we produce a NAV cap rate, and our NAV cap rate is pretty accurate. So this quarter, I think we're at a 4.7% cap rate on our net asset value. That cap rate is, I think, bolstered up by the 13 appraisals that our lenders ordered on over $750 million of our investors' assets through the quarter. I think it's further bolstered by a recent U.S. public announcement between UDR and Steadfast where we saw a contribution into UDR at $230,000 a suite. A portfolio of properties that are located in Dallas and Austin that are comparable in age, comparable and rent, comparable and occupancy to BSR's portfolio. So our view of cap rates for the second quarter as discussed in our NAV and depicted in our NAV really reflects true transactions that we're seeing in the market the actual cost of buying and selling multifamily product in the last quarter. Secondly, we think cap rate expansion is somewhat stabilized at this point. We may see a little bit more, but I doubt it that it's going to go up too much higher than it has over the course of the last 1.5 years. Now as it relates to opportunistic portfolios, yes, we've seen a handful, let's say, a couple of dozen opportunistic portfolios. I know some of those portfolios have made headlines over the course of the last month or so. I'd want to caution anyone I don't want anyone to misunderstand our view on acquisition growth. We're very particular about our portfolio makeup. I think there's a good saying that we adhere to. We'd rather buy a great property at a fair price than a poor property at a great price. If we see a portfolio or individual acquisitions priced right, we're going to acquire those. If we see an opportunistic portfolio that exists that meets our expectations, of course, we're going to pursue. To date, the portfolios that have traded do not compare and have not met our expectations to acquire and include in our investors' portfolio that they currently own. If that changes, we'll certainly pursue portfolio opportunities. But right now, the deals that have traded hands year-to-date, we wouldn't buy them under normal conditions because it violates the view of we'd rather buy a great property at fair price than a poor property at a great price.

Okay. Great. And then just switching gears to the property taxes that you expect to recover by the end of the year. Is it too soon to think about where you'd use those proceeds going forward? Or have you sort of had an initial discussion and discussed where you'd use the incremental taxes?

You mean if the tax reductions are temporary, meaning 1 year, or if we anticipate them being more permanent?

Well, [ one ] that, and then what's the use of proceeds from that? Like where do you plan to use the money that you get back?

Sure. Brandon?

Yes, Gaurav, this is Brandon. So we are optimistic that this legislation is going to pass at a constitutional election on November 7th. However, we pointed out in the press release that we have not included the impact of the reduction in property taxes in our 2023 guidance. And the way that it works in Texas is we'll get the final assessed values for those properties in Texas at the end of the year. And this new property tax legislation is going to push that date out a little bit further. So it's a little too soon for us to actually put that anticipated reduction in the guidance. Now with respect to the proceeds, I think what we would do is we would continue allocating the capital that we had in the past via NCIB or paying down variable rate debt.

The next question comes from Brad Sturges of Raymond James.

Sitting with a popular theme today on the acquisition side. Just curious, are there any new markets that would be on your radar where going in returns for stabilized products or stabilized cap rates kind of are starting to look more attractive at this stage or really where you see the best opportunities still are lease up, I guess, in existing Texas market?

Right now our view is that -- and we've said this quite some time, we surveilled dozens of markets. And if we ever think we can earn more money by deploying our investors' capital in a new market, we'll definitely take advantage of that. Right now, this portfolio can earn more money by buying assets in Dallas, Houston and Austin in that order, then we can by any single or combination of investments outside of those 3 markets. I think that's been the case for the last 3 or 4 years, continues to be our viewpoint, well into '24, well into '25 and '26. An interesting fact, we go back to Austin. So Austin and Phoenix are 2 markets in the United States with elevated levels of supply. Now they're not the national leaders in supply as a percentage of total product. In that ranking, Austin ranks 13th well behind Huntsville, Alabama as the leader. But in those 2 cases of Phoenix and Austin, those are the only 2 markets in the United States that RealPage believes the resulting occupancy in 2024 and '25 will be higher than it was at the beginning or at the fourth quarter of 2022. So even with the supply coming into those supply heavy markets, RealPage and we agree -- believes that both of those markets are going to absorb the supply and need more housing. They're not more housing -- not higher occupancy than exists today, but the higher occupancy that existed in the fourth quarter of '24. That -- it's those kind of just the basic -- on occupancy and rate increases that kind of bolster our opinion on our particular markets. And Texas in general, their behavior towards constantly creating affordable options for both the consumer and the business to operate backs up our view of why we think the Texas Triangle is probably the best place to be buying real estate in the world.

And I guess just to wrap around the lease-up optionality or opportunity, the -- is that -- are you expecting to see some distress from merchant builders that may create an acquisition opportunity? Or is there more about the partnerships you already have existing and sort of getting up some of that a little bit of extra return through the lease-up process?

We would expect this environment is certainly going to generate some distress for certain builders and across the United States. It's our view that not every product is the same. We've acquired -- and if you go back to whoever built our properties, you'll note there's some common names. We're very particular about the type of properties we buy. And we definitely place a value on the relationships that we've cultivated in the development community over the course of the last 2 or 3 decades. I don't think we're as focused on buying an incredible deal from a developer that we're not aware of. I think we're more focused on buying the right deal for our investors at the right price from a developer that builds a product that we know how to operate and a superior product to other developers.

Makes sense. Last question quickly back to the NCIB comment about expecting to stay out. Do you have a target level of capital you're willing to put towards the NCIB if the stock continues to be at this discounted year?

I think our NCIB has capped at around $35 million, give or take, of share repurchases. I believe it expires subject to renewal in October of this year. And to date, I believe, in the last 10 months or 11 months, we've acquired about $20 million, leaves us about $15 million of availability with a REIT that just produced a NAV of $20.40 on 31 properties against the trading price on the TSX at $12.90. To me, $15 million is the amount that we're able to buy before the October renewal period. It doesn't seem unreasonable that we continue that pace, but price dependent and depending with an eye towards our liquidity. Right now, it's an incredible deal. We can't buy a property at a 6.7% cap. We certainly buy our stock at a 6.7% cap.

Yes, that makes a lot of sense from a capital allocation point of view. I appreciate the comments. I'll turn it back.

The next question comes from Himanshu Gupta of Scotiabank.

So just on the portfolio occupancy, it was down around 60 basis points on a quarter-over-quarter basis. So maybe can you comment on that? And how do you expect occupancy trending in your portfolio for the rest of the year?

So occupancy has hovered around 96%, 95% for a while now, and it's still there. And we think that's normal. We think that's the sweet spot, right? If you -- if you have an occupancy that's much higher than 96%, it means that you're not charging enough. And if you're lower than 95%, you're probably not charging enough. So we use revenue maximization software to come up with the best balance of increasing rate versus occupancy. And we like where we are.

Okay. So as such, no pressure as such you're seeing on the occupancy side. This is your desired occupancy levels, what you're sticking with.

Correct.

Okay. And then on the Austin market on new leasing rate, would you say July and August are still similar to Q2? Or do you think further pressure in terms of the negative growth rates there?

So for Austin, in particular, in July, the new leases were just a CAD negative, but we were higher on renewals at 4% to give us a blended increase of about 1% for Austin in July. So as Dan said earlier, that there's -- we haven't seen a huge impact here as one would expect based on all the chatter about supply, but we continue to watch the market. As Dan also alluded to, we've got 3 assets basically in North Austin that would be impacted right now.

Okay. Fair enough. And maybe just sticking to the market commentary. Houston looks a bit more stronger or incrementally positive now, I would say, compared to recent months. First of all, do you agree with that statement? And what is causing Houston to do much better here compared to some of the other markets?

Himanshu, Houston has certainly propped up. I believe it led the country in net absorption in the month of June, and it's certainly outperforming relative to the remaining -- or to its comparable markets in the U.S. I think it's a factor of Houston staying the same speed and everybody slowing down. And I think part of that factor is you had household formations, you had population growth, I think Houston and Dallas were the only 2 markets last year that grew population by more than 100,000 people. So population continues that pace, that steady pace of growth in Houston. And the last factor is development deliveries were muted in Houston in 2020 and '21 relative to other markets that exhibited the same kind of growth. We're enjoying the benefit of that now relatively. Now construction, I would say, in the next 12 months in Houston, I think right now, we're looking at 22,500 units underway. That's about 87 properties. About 19,600 of those units are slated to be delivered in Houston over the course of the next 12 months. That's a bit high. We like Houston about 15,000 units a year. That's a bit high for Houston. But I don't think it's going to taper Houston's relative positioning on a look forward. I think it continues to be our market that grows. I think we said it 2 years ago, it's going to grow lower for longer, and it's nicely teed up in '21, '22, '23, '24, '25 to continue to deliver outsized returns operationally.

Awesome. And then just a clarification on the property tax reduction there. So this will be on an ongoing basis, right? I mean this is not applicable only for a certain number of years here.

That is correct. Assuming that the legislation passes, it will be permanent.

Okay. And just a follow-up. Obviously, this legislation is a positive event. Will there be any impact with the ongoing property tax appeals in the process right now? Do you think less pushback or maybe some benefits from those ongoing tax appeals as well?

I'm sorry, Himanshu, you didn't come to clear. Could you repeat the question?

Yes. So Dan, obviously, there is a Texas view to reduce property taxes here. And you guys do a lot of tax appeals as well. So do you think in the ongoing tax appeals, there could be less pushback from the government and you could have some better results on the ongoing tax appeals as well?

Yes, we do. I think -- so our performance year-to-date has been pleasing in Texas from an appeal standpoint. I think we have 14 outstanding appeals in the portfolio. One of the appeals is -- or 2 of the pills relates to our property Cielo in Austin for the tax years 2020 and 2021. And the other 12 appeals have to do it last year. I think what we've seen year-to-date is appeal success that's better than our expectations. And if that continues to carry out in conjunction with these permanent millage increases passed by the state of Texas that look to be passed by the voters of Texas, I don't know, I mean maybe the voters don't pass them, Himanshu, but I don't know a lot of voters that are going to vote against the tax cut. But those 2 things in combined, what we're seeing right now, so long as it holds up, is a much better-than-expected tax appeal and tax rate environment in Texas this year and on an ongoing look forward, I would contrast that with Florida right now that I think is probably going the other direction from a tax standpoint.

Got it. Last question from my side. Obviously, a lot of discussion on the external opportunities. So my question is on the capital recycling, any thoughts there? I mean, you have a history of selling a large product portfolio in the previous cycle or so. Any thoughts here to fund those opportunistic acquisitions or buybacks?

Sure. And maybe I should clarify that I think the REIT has a history of depicting assets that it's sold and trading into making good decisions, selling swinging from ropes. Internally, what we do all the time every day is we rank our properties by return on fair market value of equity. And if we think we can sell any property in the portfolio and rotate those funds and generate a higher return for our investors, we're not going to -- I think we've shown we're not going to blink. We're just going to move and do it. So at any time, right now, we like the capitalization of our properties, we like how much money they're making. If we saw an opportunity to sell our Oklahoma City properties or even our Austin or our Dallas properties and make more money, then we certainly would. It's not necessarily market or property dependent. It's more return on fair market value of equity dependent. That's what's driving the shift. We've got time for one more question, I believe, Michelle.

The last question comes from Jimmy Shan of RBC Capital Markets.

Just sneaking one little question on the acquisition. Maybe if I could put it this way, Dan, you mentioned looking to buy a great property at a fair price. What would you consider fair to you? What appropriate spread to the mid-5, high-5s posit debt that you'd be willing to pay on a stabilized asset that gets you back in the market?

Yes, sure. First of all, we're probably not going to fix our debt at the mid-5s, right, at this moment. We see better opportunities. I think that's perfectly depicted by our forward swap. We executed at 2.25% in the quarter. So it's about financing around the curve. Jimmy, we like around a 100 basis point to a 125 basis point spread from cap rate to a fixed cost of debt to acquire accretively a stabilized apartment project. We like a tad bit more than that, call it, $125 million to $150 million to acquire a lease-up project, and we like about 2% or better to develop a project. Right now, we think that the spread on stabilized is much lower than 100 basis points. We think that the spread on lease-up is wider in the market than 125 to 150 basis points. And we think the development yield, the yield the TDC against the cost of capital is roughly double that of lease-up acquisitions at this point. And just from an underwriting standpoint, we look at a 3-year fixed rate cost of funds, a 5-year fixed rate cost of funds in our models. And we're underwriting to a yield-driven return in the low to mid-teens for our acquisitions. That hasn't really changed in the last, call it, 10 or 15 years since we've been working our models and our acquisitions. Does that provide enough data or was that clear as mud?

That's very clear, not as mud. But just one thing I wanted to clarify, though, you had mentioned at the outset you don't look at your cost of debt that way. So when you say 100 to 125 basis points as the fixed cost of debt, what are you referring to here in terms of fixed cost of debt?

Yes, sure. Relative to market cost?

Yes.

We'll look at the return for our shareholders against the BSR's owned fixed cost of debt, and we'll make a judgment call on the market, I'll say, the market overall cost of debt. So you're making a good point. If we can finance it 4% and buy a 5.5 cap stabilized asset, that's accretive for our investors. That's very accretive for our investors. Even in an environment where the market is -- the market for 5- and 7-year debt might look like 5% to 5.5%, we're able to make money with this platform when perhaps Fannie Mae and Freddie Mac can't finance those funds. And I think that's probably the environment we're walking into, Jimmy. The prevailing issue in real estate has nothing to do with supply or renters being able to afford things in markets or stock prices. The prevailing issue in real estate is the cost of debt and the tightening of the lending market. We've seen commercial real estate, smaller and regional banks precipitously pull back on their ability to deploy capital and their willingness, which cuts out development. That's who developers use to finance projects, right? We see Fannie and Freddie completely open for business, but wanting to finance with their $75 billion respective annual caps for financing. They're wanting to finance at 5.5% and 6% rates. And usually, at this time of the year, we're talking about expanding those caps, right now, I think Fannie's done 25 or 75, it's done 1/3 of its annual cap limit. Borrowers are just not going to borrow at 5.5%, probably see more over-equitized deals similar to the UDR deal that was done at the beginning of July, all cash deals, things of that nature, where borrowers are probably more -- they understand the value of the asset, the compound annual return and the appropriate cap rate to apply. They just might not use debt to do it at this point. If we have the ability to and we can do it accretively, we'll do it. I think if others have that same ability, they would do it.

I will turn -- I'm so sorry, please go ahead.

No, that concludes our call today, everyone. Thank you for joining us, and we hope you enjoy the rest of the summer and look forward to speaking with you again after we report our 2023 third quarter results. Thank you all.

Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.