Canadian Apartment Properties Real Estate Investment Trust (CARUN) Earnings Call Transcript & Summary

Hello, and welcome to the Canadian Apartment Properties REIT First Quarter 2023 Results Conference Call. My name is [ Elliot ], and I'll be coordinating your call today. [Operator Instructions] I would now like to hand over to Nicole Dolan, Investor Relations. The floor is yours. Please go ahead.

Thank you, operator, and good morning, everyone. Before we begin, let me remind everyone that during our conference call this morning, we may include forward-looking statements about expected future events and the financial and operating results of CAPREIT, which are subject to certain risks and uncertainties. We direct your attention to Slide 2 and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Kenney, President and CEO.

Thanks, Nicole. Good day, and good morning, everyone. Joining me this morning is Stephen Co, our Chief Financial Officer; and Julian Schonfeldt, our Chief Investment Officer. Let's get started with an overview of our operational performance on Slide 4. We continue to see strong rent growth across our Canadian apartments, which account for approximately 80% of our total portfolio value. We've been maintaining this track record while also keeping near-full occupancies, with 98.6% occupancy at March 31. On a same-property basis, occupied AMR for our Canadian residential portfolio was up by 5% compared to Q1 of 2022. Moving to Slide 5. This rent growth has been the main driver of the increase in our NOI margin, up by 0.7% versus the prior period. On a same-property basis, our margin was up by 0.6%. Diluted FFO per unit increased by 2.2% despite headwinds in interest, accelerated CMHC amortization, septic system maintenance costs and elevated G&A, mainly from wage inflation. Our active NCIB program contributed to the increase. [ FAS ] did a nonrefundable deposit received on a property disposition that did not close. We are proud to have maintained a constant distribution rate and a conservative FFO payout ratio, which was 63.6% for the quarter. Diluted NAV per unit at March 31 was $57.47. This decreased slightly compared to Q4 due to the fair value loss on our European portfolio, partially offset by NCIB repurchases. We also continue to make good progress on our CAPREIT 2.0 strategy, which is summarized on Slide 6. On the Canadian apartment front, we're improving the quality of our portfolio by disposing of noncore properties and acquiring new construction assets in attractive markets. We are also working on entitling and selling our excess land. This generates additional funding for us to allocate toward CAPREIT's core competencies but more importantly, it helps to bring housing to the Canadian marketplace. Right now, we have incredible capital deployment opportunities. In addition to our focus on new purpose-built rental apartments, we are also allocating files towards our value-enhancing NCIB program, which Julian will expand on shortly, together with our active debt management program that Stephen will then speak to. I will now turn things over to Julian to provide an update on our capital recycling and strategic repositioning.

Thanks, Mark. Turning to Slide 8, you can see that we've been gaining traction on the strategic repositioning of our portfolio over the past couple of years, and we continue to make solid progress in 2023. So far this year, we have already executed on $178 million worth of dispositions and have acquired $84 million in targeted new construction rental assets. That brings our portfolio allocation to 9% new build today versus only 1% just over 5 years ago. Slide 9 provides a great snapshot of some of the strategic recycling we've done in the first quarter of 2023 and displays the type of asset which we're purchasing versus selling. In January, we disposed of our nonmanaging interest in 3 older noncore properties and a mid-3% cap rate. We paid down higher interest rate debt, and then in February, we reallocated some of that capital back into Ottawa through the purchase of this newly-built Eagle Pointe asset. It has strong growth profile, low CapEx needs, and we were able to acquire it at a mid-4% cap rate at a price that is below replacement. In March, you will see on Slide 10 that we completed our first disposition of entitled land as part of our Reenvision development program. The underutilized parking lot site is located next to a property we own in Montreal, and we undertook the end-to-end entitlement process to obtain building permits for approximately 280,000 square feet of gross floor area. We then sold the site to an experienced local developer to do what they do best and received cash proceeds of just over $17 million, which works out to a strong sales price of $62 per billable square foot. Not only will this soon give rights to residential accommodation needed in that growing neighborhood, but we were also able to effectively monetize the majority of the prospective development profit upfront without having to take on the development risk. It's a win-win for our community and for our unitholders. Looking ahead, we've identified over 6 million square feet of possible GFA across potential development sites in the GTA alone. In partnership with development managers, we have submitted several planning applications for new residential buildings, which together provide for the construction of 2 million to 3 million square feet of new residential GFA. Subject to municipal approval, these will help to address the increased demand for high-rise residential intensification in high-growth and major transit station areas across the city. Net disposition proceeds from our development and repositioning programs are then in part funneled into our NCIB, as summarized on Slide 11. We've been very active on this front given that it provides a strong and ongoing source of accretion, and to date, we have made over $338 million worth of repurchases at significant discounts to NAV. In the first quarter of 2023, we purchased and canceled 2 million trust units at an attractive weighted average price of approximately $46 per trust unit, generating meaningful value for our unitholders. With that, I will thank you for your time this morning, and I will now turn things over to Stephen for his financial review.

Thanks, Julian, and good morning, everyone. Our NCIB strategy goes hand-in-hand with our active debt management program, and both also depend on the timing of our acquisitions and dispositions. Referring to Slide 13, you can see that we got $266 million in accessible liquidity at March 31 from cash and available credit on our Canadian facility. This balance fluctuates as we allocate excess proceeds from our strategic recycling to pay down this higher interest rate debt while also using the facility as temporary funding in between disposition dates. We're expecting the latter to incur elevated interest costs in the near term in anticipation of top-up financing in the latter part of the year, including disposition proceeds. We also proactively manage our mortgage refinancings and top-ups and are expecting to up-finance between $250 million and $300 million in 2023. Our mortgage portfolio is almost fully fixed, and currently carries a low weighted average interest rate of 2.6%, with a weighted average term to maturity of just over 5 years. Not only that, but you can see on Slide 14 that no more than 13 % of our Canadian mortgages come due in any given year, which reduces renewal risk and gives us flexibility in this volatile interest rate environment. And finally, Slide 15 shows how we've consistently growing our asset base while also strengthening the balance sheet. We've got one of the lowest leverages in our peer group with a debt to gross book value ratio currently at 40%, while our coverage ratios remain conservatively high. I will now turn things back over to Mark.

Thanks, Stephen. As we reflect on CAPREIT's first quarter of 2023, I just want to take a step back to look at the extraordinary conditions that are affecting Canada's housing market. It's impossible to deny that the housing affordability crisis in Canada is directly co-related to demand for homes in Canada. This demand is primarily driven by population growth. From Statistics Canada, we've taken a look back at population growth since the year 2000. And as you can see on Slide 17, the fundamentals support our view that the affordability crisis in Canada start to show its first sign in 2015. However, COVID changed the trajectory of apartment affordability, population growth, tapering off and households consolidating. This temporarily masked the increasing shortfall in housing supply, which then caught up dramatically as the pandemic eased. We believe these fundamentals form the root cause of the affordability crisis. As one of Canada's largest providers of residential housing, we are critically responding and have been prioritizing our contribution to the solution. Along with our fellow Canadian REITS, we are actively doing everything we can to bring things back into balance. For reference, you will see on Slide 18 that Canada has had the highest population growth rate in the G7 and ranked seventh in the G20, and yet we have the fewest homes per capita in the G7, despite having the most buildable [indiscernible] and the lowest population density. It is, therefore, no wonder that we have the most expensive housing market in the G7. On Slide 19, combining this extreme population growth with a persistent lack of housing supply, the result is the steady decline in housing affordability, and this is driving demand for rental accommodation. In 2022, Canada's purpose-built rental apartment vacancy rate fell to 1.9%, which is its lowest level since 2001, reflecting the widespread tightening across all of Canada's rental markets. According to CMHC, it is projected that an additional 3.5 million new housing units are needed by 2030 to restore affordability in Canada. On Slide 20, you can see the gravity of this gap. For context, this represents approximately $2 trillion worth of new construction. This is over and above the 2.3 million new homes estimated to be built by 2030, which assumes the current rates of construction continue, but construction costs are rising rapidly. In 2022, the cost of constructing a residential building rose by nearly 20%, a double-digit increase for the second consecutive year according to Statistics Canada. CMHC also just recently predicted that housing starts will decline significantly in 2023 due to elevated construction and financing costs as well as the labor shortage, making the situation even more difficult. Slide 21 points to where the problem is concentrated. CMHC estimates the supply gap to be the greatest in the largest, most in-demand markets, which are the most unaffordable. And as a provider of housing, that's exactly where you'll find CAPREIT. 80% of our residential suites in Canada are located where supply shortfalls are the greatest, and that's in the top 5 most unaffordable cities. With the vast majority of our portfolio located in the most unaffordable markets, you can understand how these 2 crises, the housing supply crisis and the affordability crisis, are coming together to drive up demand, and therefore, mark-to-market rents on turnover. That said, when we look at our portfolio as a whole, as shown on Slide 22, you can see the uplift on turnover affect only a minority of our suites. Most of our portfolio received an average sub 2% rent increase on renewal, entirely in line with regulatory rent caps and guidelines that apply to almost all of our Canadian suites. Looking at our most recent full year, we renewed 90% of our leases across which the average increase was only 1.4%. Including both turnover and renewal, our Canadian weighted average uplift on the Canadian residential portfolio was 3.4% and 3.7% in this most recent first quarter. This graph highlights another trend as demand for rental accommodation drives up market rents. CAPREIT's in-place residents are experiencing rents that have fallen well below market value. You can see the steady decline in our turnover rate over the past decade, with only 2.6% of our suites turning over in this most recent quarter, which would be just 10% turnover on an annualized basis. Compare that to the 35% turnover that we saw back in 2010. Slide 23 demonstrates that we are providing affordable accommodation in increasingly unaffordable cities. In fact, nearly half of our suites are designated as affordable according to the CMHC measure of affordability. In our largest markets, which are the least affordable markets, our average rent-to-income ratio is significantly less than that of the market, and that is required for homeownership. Which brings me to our final Slide 24. As one of the largest providers of residential housing in Canada, we acknowledge the impact we can make in helping to resolve the housing crisis and we are now sitting on the -- and we are not sitting, I should say, on the sidelines. We also prioritized the primary duty that we have to our residents and the communities that they live in. We aim to continue setting the precedent when it comes to responsible and accountable property management. Importantly, we are working to achieve all of our ambitions while also seeking the strongest returns for our valued unitholders. Our objectives are not mutually exclusive, and we intend to continue making progress on all fronts as we move forward in 2023. Thank you for your time this morning, and we would now be pleased to take your questions.

[Operator Instructions] First question comes from [ Jonathan Kelcher with TD Cowen ].

First question, just following up on the turnover at 2.6%, which I think is probably the lowest you guys have ever recorded. Q1 is normally a slower period, but how do you think that plays out the rest of this year? What do you think the year ends up at?

I think you'll see a normal curve with respect to seasonality, but just lower overall churn. So I think we're comfortable that we'll probably see in the Canadian apartment portfolio 12%, maybe 13% churn for the year. That's a guess, obviously. But based on what's happening, the seasonal curve will stay and the trend will probably also follow.

Okay. Is there any -- like I'm assuming Toronto would be among the lowest with your turnover. Are there any markets that stand out, like either low or high relative to your average?

No, it's pretty much settled in, in terms of an issue from coast to coast. I would say that some of the newer construction assets that we've been purchasing are experiencing slightly higher churn because the market rents are closer to market. That being said, we're seeing very strong increases on those assets as well, but no particular geography that's standing out.

Okay. And then secondly, just on the mid-20% increases that you got again this quarter, is that something we could expect to see carry through in over the next couple of quarters? And what markets were the strongest in that regard, if any?

Yes. We're going to -- we're going to see a flattening. We're getting the COVID impact here, clearly, CAPREIT was very cautious with rent setting during COVID. And so as we come out of COVID, we're obviously seeing some of those rents that were at least closer to market come to bear. So I wouldn't say it's an ever-increasing trend. We might see a flattening down. And sorry, the second part of your question, which markets?

Any market, yes.

Yes. Toronto absolutely stands out as being a market of incredible potential. In particular, Southwestern Ontario, and you certainly can't ignore what's happening in Calgary and Vancouver.

So almost all except Montreal?

Montreal, we're seeing new construction portfolio for CAPREIT. We have the struggles of lease up there during the worst possible time, but no, we're seeing oxygen back in that marketplace in terms of occupancy. We are not seeing Toronto-level rents, but we're going to be seeing double digits in the strong end here pretty soon in the quarters to come. Again, all of the -- all the time show revenue. Quebec really does come middle of summer, June, July, so we're looking forward to seeing some full recovery by that period of time.

Our next question comes from Kyle Stanley with Desjardins.

Julian, just on your outlook for additional capital recycling for the year, I mean you've now done close to $180 million, I think, on the year. Would that imply another kind of $300 million to $350 million? I think kind of based on your previous guidance that was kind of in the range, but I'm just wondering if your outlook has changed at all?

Yes. Thanks for the question, Kyle. We initially said we were targeting $500 million, and we're still on track for that. This is always subject to markets and demand, and as we've discussed earlier, a lot of these transactions are with private buyers so there's a bit higher execution risk. But we feel confident we'll be able to get past the $500 million mark for the year.

Okay. Great. And I guess just to your comment there, there hasn't really been a shift in the potential buyer pool. It still is primarily some of the smaller private investors at this point?

No, it's largely the smaller private buyers. We think as interest rates stabilize, rent growth goes up, inflation stabilizes. You might start to see some of the institutions coming back in, but it is still predominantly the private buyers.

I think last quarter, you mentioned -- sorry.

Sorry. Just to build on that, in terms of volume and transaction, we've now entered the period of the lowest amount of apartment transactions Canada has seen in about 15 to 20 years. So again, I think the market is readjusting, as Julian said regarding institutions on the sidelines that have kind of been waiting for a clear path and the private sort of anxiously clamoring to get to the table. So it's just not shown up yet. It's really important to note just the volume of transactions is incredibly low, but that doesn't necessarily mean it's going to stay there. We view that as just a signal that it's about to pick up again.

Okay. Great. I'm just wondering, so last quarter, you mentioned on the same property OpEx line looking for kind of 4% to 5% annual growth and maybe hitting the lower end of that. I mean -- I think we saw that this quarter. Just confirming that that's still the expectation?

Yes, I think, when we're tracking the forecast, I think I'm still within the 4%, 5%. Again, it all depends on timing of R&M costs and whatnot, but -- and utilities that which can fluctuate, but I am still guiding 4%, 5%, rates continue to be low. And the -- whether it's continue to be mild, then I would say we'll be on the lower end of the range.

Our next question comes from Mike Markidis with BMO Capital Markets.

CAPREIT's team. Mark, I don't know if you're willing to talk about this, but maybe if you could just touch on how your government engagement has evolved since the budget has been released?

Yes. I think along the lines of what I said probably in the last call, maybe one before, it's definitely been a journey of education, and we have had tremendous interest in learning more from federal government. The -- I would describe the environment now just as one of better understanding. There are a couple of housing committees that are underway in Ottawa and the voice of the industry is definitely being heard at those committee meetings. One just cannot deny that the cause of affordability now is clearly in the direction of population growth and building starts that we talked about in the presentation. There was definitely a period of time when frustrations were forcing people to find to bogeyman, and the bogeyman is definitely population growth and the inability to kind of match housing needs with that population growth. So as we spread that word and I would encourage all the Canadians to spread that word, we have a struggle in front of us with the population growth ambitions that the country has started to undertake and has in its view. Without warehousing, we are going to stay in this very dirty sized affordability crisis.

Okay. And then just following up on that line of topic. Is the focus mainly with the current governing party? Or just given -- I mean it seems like it's far away, but 2025 will be year before you know it. Is there any effort on the opposition side as well?

We've taken an approach of all parties that are needing this education. Political parties come and go, and the housing file is one that has, at least at a federal level, never really been sort of top priority as we've had housing affordability in Canada for so long. But it's all-party communication. In fact, we're putting an exorbitant amount of effort into the parties that are the most skeptical. And the parties that you would expect to be the most understanding, just -- they need the latest conversations, quite frankly. So yes, we are definitely not stopping and the battle continues at the provincial level because premiers are all struggling with the same vote or pushback of housing affordability. So keeping the file active at the provincial level is something that we're also on.

Okay. Great. Last question for me before I turn it back. Just with respect to your capital deployment opportunities, get the focus on the NCIB and debt repayment. Historically, CAP's been a dividend aristocrat. Just curious if you could give any thoughts about where your head is on the distribution these days?

Yes. Listen, cash came right now. As our payout ratio drops, we certainly have a more comfortable retention of earnings situation, and that is something that we're seeking. The team constantly talks internally here but lowest cost of capital being the winning real estate company, and all of our attentions are turned to how we can best use low-cost capital, and that is the mission. So just really happy to see the growth of earnings in the entity. This is a trend that's going to continue to reveal itself more as we go through 2023. And what we do with those earnings is going to be really, really important for the future.

We now turn to Jimmy Shan with RBC Capital Markets.

So on the $6 million of additional density that you mentioned, have you penciled in some sort of time line on when you expect to get these done? And then how are you approaching the rezoning work again? I think you had mentioned you're partnering with developers, and they're going through the process. Maybe you could just give us some color on that? Would be great.

Yes. Thanks Jimmy. So right now, we have our 10 green sites, which we submitted an application for in March for over 2 million square feet of density. And then we've got 2 sites in Midtown near Yonge and Davisville, about 300,000 each. We're expecting approvals maybe later this year or early next year on one -- another one later in next year and then another one, maybe the year or 2 after that. I mean these take time. We've got a few other sites. We've looked at and mapped everything in the GTA and have a good grip on the potential here, and we're going to put a few other ones into that process as well. And hopefully, we'll have stuff to announce over the near to mid-term. But the approach that we've been taking with that is, and especially on those sites where there's a bit more complication like rental replacement, multiple phasings, we've been working with large, best-in-class developers here in Toronto, who have just been partnering with us, helping consult through the entitlement process. Going forward, depending on the site, we may do that or we may do it internally if it's very simple kind of until the development, but we maintain the flexibility on it and to do as we see best fit.

Okay. And then at some point, once you've gone through that rezoning process, the goal is to somehow monetize finding another partner to come in along with the developers that you have working on those projects? Is that how...

It's likely to be a monetization, Jimmy. Here in Toronto, the vast majority of development is condo development. We're not condo developers. It's not our business. It's the primary business of those other entities, and so for our end, it would be just to monetize it and redeploy it back into our bread-and-butter business, being acquisitions of new builds and share buyback, debt repayments and those types of things. Whether it's the developers that are consulting with us or others, we also have that flexibility.

Right. Okay. Great. Last question. Just in your discussion, Mark, with the government and sort of the recognition of the demand-supply mismatch, do you get the sense at all that they may change or lower their immigration targets? Is that part of the discussion?

No. I think Canada has been built on the foundation of immigration. That immigration is loved deeply by all Canadians. It resonates with voters. And that is something that at the federal level where integration is controlled, politicians have to be mindful, I guess. At the provincial level, it's definitely understood. We even have premiers on the left side of the spectrum calling for more supply across Canada, which is encouraging. I said to Stephen and Julian in particular, we've got the wind in our sails now on intensification of our CAPREIT lands. The decision to hold off or the consequences of not being fully organized have been -- will turn out to be a very valuable one for CAPREIT because the monetization of our land will be, I think, just jaw-dropping given the current environment and municipal appetite to grant density. It wasn't so long ago that not in my backyard was kind of a local saying, and I think Canadians are waking up to the fact that we have a supply crisis, that this is for sure. I'm not quite sure they've linked population growth with that yet, but we're going to win on the intensification side and sadly will benefit by disproportionate population growth attribute. Country just really needs to get building, and in particular, building on lands that just require municipal services to be rebuilt to give us the density we need. We have lots of land in Canada. We can solve this problem. Quite frankly, the problem is held at the municipal level where the capacity for municipal services is also going to determine how much housing can get built. So there's -- it's not the most difficult problem in the world to solve. It's the competing ambitions of 3 levels of government that we have to work with.

We now turn to Matt Kornack with National Bank Financial.

Just wanted to quickly talk on the capital recycling as well as mortgage up financing front. You have a line of credit still drawn at 6% interest rates right now. Should we expect that some of the used proceeds on future dispositions or on up financing would be used to reduce outstanding balances?

Matt. Yes, absolutely. I think I can have daily conversations with both Mark and Julian when those dispositions do occur and those funds just come in. It's really the allocation between new build construction assets where we buy them or NCIB or paying down debt, and right now, our appetite is really to pay down debt. I kind of alluded in prior call that I like the long-term LTV view around 35% to 40%, where we're currently just up 40%, and I want to get that leverage ratio down to under 40%.