European Residential Real Estate Investment Trust (EREUN) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the fourth quarter 2019 results conference call. I would now like to turn the meeting over to Mr. Burns. 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 our future financial and operating results. I direct your attention to Slide 2 and other regulatory filings. Joining me today is our CFO, Scott Cryer; and our VP of Finance, Stephen Co. After I provide an update on our operational progress during the quarter, Scott will give an overview of our financial results and position. Turning to Slide 4. Just to remind everyone, ERES was formed on March 29 through the reverse takeover of European Commercial REIT. The transaction combined CAPREIT's 2,000 plus rental units in the Netherlands with European Commercial REIT's 3 commercial properties, creating Canada's first European-focused multi-residential REIT. Importantly, CAPREIT is the property manager and asset manager for ERES, bringing their proven value-enhancing platform to the REIT. CAPREIT has had a presence in the Netherlands for some time and is fully aligned with the interest of all ERES unitholders through their majority ownership in ERES. Slide 5 outlines a few highlights from the quarter and how we are achieving our stated objectives. Our main goal is to rapidly and accretively increase our size and scale in our target markets. During the fourth quarter, we acquired another 2 portfolios comprising 516 residential suites, ancillary commercial space and a garage in the Netherlands, increasing the fair value of our total portfolio to over EUR 1.3 billion at December 31. Subsequent to year-end, we closed on the sale of the commercial property located in Dusseldorf, Germany for a total gross proceeds of approximately EUR 17 million and an implied capitalization rate of just under 4%. To fund our growth, we completed an offering of 30.9 million trust units in December, raising approximately EUR 95 million or approximately CAD 138 million. The proceeds were, in part, used to pay -- repay EUR 50 million of our new 1-year bridge revolving credit facility and EUR 23 million of our revolving credit facility, thus increasing our future acquisition capacity and flexibility. And with our portfolio growth over the last 12 months, we generated solid accretive growth in both FFO and AFFO per unit for the year 2019, rising 15% and 2.6%, respectively, despite the 73% increase in the weighted average number of units outstanding compared to last year. As seen on Slide 6, we continue to increase the size and scale of our portfolio and look for further growth in the quarters ahead. With our property purchases since inception, our residential portfolio totaled 5,632 suites at December 31, well located in growth markets across the Netherlands. We also own commercial properties in Belgium, Germany and the Netherlands. In total, the fair value of the portfolio was EUR 1.35 billion or CAD 1.96 billion at December 31. As previously mentioned, subsequent to year-end, we closed on the sale of the commercial property in Dusseldorf, Germany. This disposition is in line with our pursuit of our multi-residential growth strategy as we continue to make strategic alignments and capitalize on opportunities to enhance the value of ERES. Looking more closely at our residential portfolio on Slide 7. You can see that our suites are nearly evenly divided between regulated and liberalized suites, providing balanced growth potential in rents as well as the opportunity to liberalize more suites. Importantly, about 1/4 of our current portfolios are located in the high growth urban markets of the Randstad, including the cities of Amsterdam, Rotterdam, The Hague and Utrecht. The rest of the portfolio is situated in smaller urban centers throughout the country. Slide 8 provides more detail on our current residential portfolio as well. Average occupied monthly rents were EUR 825 at the end of December, with a high and stable occupancy of 97.2%. Portfolio is well diversified by number of bedrooms, ensuring we meet the demand for smaller units as well as for families. You can also see that approximately half of the current portfolio was constructed since 1980, provided an average age of under 40 years, resulting in lower ongoing repairs and maintenance costs and driving higher asset values. As mentioned, our portfolio also includes commercial properties in Germany, Belgium and the Netherlands, as detailed on Slide 9. With an occupancy of just under 100%, a weighted average lease term of 5.7 years and low fixed interest rates, these properties are expected to provide solid and stable cash flows going forward. And with that, I will now turn the call over to Scott.

Thanks, Phillip. Slide 11 highlights another strong quarter of acquisitions, along with the spread between the cost of our acquisitions and the fair value of these properties at December 31, 2019. As you can see, with our all-in cost of approximately EUR 173.7 million, the fair value of these purchases has increased EUR 174.8 million, a gain of more than EUR 1.1 million in the fourth quarter. This gain speaks to the strength of the residential markets in the Netherlands and confirms that we are buying the right kind of residential properties. Turning to Slide 12. You can see that the increase in our size and scale is having a significant and positive impact on our financial and operating results. For the 2019 year end, operating revenues were up 100% on the contribution from our acquisitions as well as an increase in monthly rents in the stabilized portfolio. This revenue increase from acquisitions, combined with lower operating cost on stabilized properties, drove 114% increase in our NOI, with a strong consolidated NOI margin of 76%, reflecting the strength of our acquisitions as well as the commercial property contribution. FFO per unit increased by 15% for the 12 months ended compared to the prior period due to higher NOI on a same-property basis and accretive acquisitions, which resulted in large spreads against mortgage rates. AFFO, on the other hand, increased by 3% compared to the prior year as nondiscretionary CapEx in 2018 was based on actual spend of only EUR 72,000 or EUR 72 per suite, whereas 2019 is based on nondiscretionary CapEx reserve of EUR 593 per suite. As detailed on Slide 13, our portfolio is generating solid organic growth through higher stabilized occupied AMR, reduced operating cost and increased scale. Our residential fleet count more than doubled in 2019 due to the significant increase in the size of our portfolio, resulting from our acquisitions over the last 12 months. Occupancy was strong and stable at 97.2%. The decrease compared to last year was primarily due to acquisitions during the third and fourth quarters of 2019, which had slightly lower occupancies than the rest of the portfolio when brought in. Occupied average monthly rents on our stabilized portfolio increased by 4%, a result of contractual indexation and renewal uplifts, along with our operating strategy of maximizing in-place rents. Stabilized portfolio NOI for the 2019 year-end increased by 11%, driven by higher operating revenues from increased monthly rents as well as reduced operating expenses from lower R&M costs and lower property management fees. Finally, our weighted average interest rate continued to decrease, down 38 basis points at year-end compared to the same time last year, and further supporting the strong spread we are seeing between cap rates and interest costs. Now turning to Slide 14, we dive into more details on the general and administrative costs during 2019 and what we expect in 2020. We have also provided additional information in the MD&A regarding our unit-based comp and income tax expense estimates for 2020. The G&A costs were higher in the fourth quarter compared to prior quarters. The increase was primarily due to higher year-end tax on a third-party valuation of other costs in connection with the REIT's first year of operations, of which a majority of the expenses were recognized in the fourth quarter. Looking into 2020 year, based on the existing portfolio of properties, we expect the G&A to fall within a EUR 7.8 million to EUR 8.5 million range. As we continue to scale the business, we remain focused on maintaining a conservative financial profile, as we can see on Slide 15. Despite the rapid and significant increase in the size of our asset base, we are seeing conservative leverage, which we expect to keep somewhere between 45% and 50% as we continue to grow, lower interest costs as a result of persistent low rates in the European Union and a conservative 5.3 year term to maturity for our portfolio. As previously indicated, the undrawn portion of our revolving credit facility and bridge facility provides us with approximately EUR 74 million in liquidity, heading into the 2020 period. Using the same 60% LTV ratio on long-term mortgage financing, we have immediate capacity to acquire up to EUR 185 million in assets. Slide 16 provides more detail on our mortgage portfolio. We continue to stagger the maturity profile of our mortgages with nothing due until 2022. As we continue to grow, we will ensure we continue to have a smooth maturity profile in order to reduce renewal risk. I thank you for your time this morning. I'll now turn things back to Phillip to wrap up.

Thanks, Scott. In summary, 2019 was a busy and successful year for ERES as we increased the size and scale of the portfolio and generated strong and accretive growth in all of our key performance metrics. As we continue to grow and execute on our stated objectives, we believe ERES offers a compelling investment opportunity. The REIT provides a unique opportunity to invest in the fast-growing and attractive European multi-residential real estate market. Our partnership with CAPREIT brings significant benefits to our unitholders. We are growing our portfolio at very attractive yield spreads with strong and highly accretive organic and external growth opportunities. We established a strong foothold in the Netherlands multi-residential market, and we are building size and scale to drive value going forward. Our conservative balance sheet and financial position provides the flexibility and resources to drive further growth, and we have in place an, experienced management team and a seasoned Board of Trustees. Thank you for your time this morning. And we would now be pleased to take any questions you may have.

[Operator Instructions] And the first question is from Brad Sturges from IA Securities.

Thanks for the color on the G&A guidance. I just want to clarify on that. That's based on the portfolio composition today as a run rate?

That's right.

Yes. So in our first year of operations, obviously, we've really been operating for 9 months with a lot of these costs on it and tax compliance, et cetera, really 12 months’ worth of cost. So there's definitely a higher run rate going into this year. So we just wanted to make sure people had a good sense of what next year looks like. But yes, that doesn't include any growth that -- acquisition that might be contemplated that will mostly affect the asset management fees.

The G&A we wouldn't expect to grow linearly going forward.

Yes.

And the plan is still to move to the TSX. So would that cost be baked into the guidance number?

No, that cost is not baked into that number. But there will be disclosure around that onetime costs when we do go up. And it's approximately around 200,000 -- CAD 200,000 if you need that cost.

You would bear that cost in the first quarter?

It will be when we graduate, but it's a nonrecurring cost. It's a onetime fee for graduating. But I would say, expected in the second half of the year.

Second half. Okay. And then in terms of expectations for rent growth on renewal, I guess, you're in the renewal process now. And any thoughts on where you think that could land this year?

Yes. I mean, we are going through the process now. Again, I think our overall rental growth target remains unchanged at or near 4%. As you all know, it's generally a CPI-plus environment. CPI last year for indexation purposes was 1.6%. The government's announced the CPI metric for 2020 at 2.6%. So that's a positive tailwind there. But across the board, we still expect to be at or near 4% for our portfolio growth for the year.

The next question is from Jonathan Kelcher from TD Securities.

First, on acquisitions, are you guys still seeing a lot of opportunities?

Yes, we definitely are. I think at the last call, I might have mentioned towards the end of the year, it slowed down a bit. In total, we reviewed well over EUR 1 billion just post RTO, but that was quite busy in the summertime and going into the fall. But now as we're sitting here today, the acquisition pipeline and opportunities has increased quite substantially, where on the table today, we're reviewing over EUR 500 million worth of acquisition. So we feel very confident about the product being out there and the opportunity to continue to grow.

Okay. And then just turning, you guys have, I guess, 33 suites undergoing renovation and 31 that you just finished. How many of those are being converted or liberalized?

I don't have number off the top of my head, Jonathan. We can send you an e-mail on that.

Okay. Now like, generally speaking, though, is like when you're -- what renovations would you be doing on suites that aren't being liberalized.

Again, it can be minor upgrades. We could be putting in a new boiler, we could be putting in new appliances, much more minor. So it just depends upon how long the tenant has been in place.

Okay. And then do you have any expectations, like, I guess, turnover was up a little bit in 2019 versus 2018. What would your expectations be for that this year?

I think that is the right range, sort of flat in the 12%, 13% range with what we would have seen over the past couple of years. Although it is slightly up, I don't see a meaningful movement in that turnover rate.