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

Good morning, ladies and gentlemen. Welcome to the fourth quarter and year-end 2020 results conference call. I would now like to turn the meeting over to Phillip Burns. Please go ahead, Mr. Burns.

Thank you, operator, and good morning, everybody. 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 our other regulatory filings. Joining me today is our current CFO, Stephen Co; and our former CFO, Scott Cryer. After I provide an update on our operational progress during the quarter, Stephen and Scott will provide an overview of our financial results and position. 2020 did not transpire as we originally anticipated at this time last year, a sentiment that is certainly shared industry-wide and globally and felt both economically and socially. Notwithstanding one of the most unprecedented and widely challenging years of modern times in general, but also in the context of only our second year of operations, it is with pride that we are reporting strong operating results for the year-end December 31, 2020, which we are happy to walk you through today. As you can see on Slide 4, although we proactively paused on acquisition activity earlier in the year as a temporary precaution in light of the great amount of uncertainty as to the unforeseen impacts of the COVID-19 pandemic, we nevertheless were able to recommence accretive expansion in the later half of 2020. To that end, we grew our suite count by 415 units across 8 properties, which we acquired in the third and fourth quarters for an aggregate purchase price of EUR 81 million, representing a blended cap rate of 3.9%, excluding cost and fees. Inclusive of the fair value appreciation on our portfolio of EUR 46 million, which we recognized during the year-end December 31, 2020, the market value of our assets under management grew to EUR 1.47 billion at year-end, up 9% from last year. This reflects positively on the strong characteristics of the Dutch multi-residential sector, which we have been highlighting to date, alongside ERES's positioning in this continuously active market. 2020 provided an opportunity for the asset class to demonstrate its defensiveness, built upon the cornerstone of countercyclicality. It likewise allowed for ERES to prove the resilience of its platform, the high quality of its portfolio and its ability to continue operating safely while also accretively growing, all despite the adversity surrounding COVID-19. Although our market capitalization has fallen victim to the ambiguity of the circumstances, the internal and external fundamentals of our business in our primary market tell a different story. On that note, despite the fact that ERES's units continue to trade, influenced by this market-wide sentiment of apprehension, and therefore, remain disconnected from its performance and fundamentals, we still graduated from the TSX Venture Exchange to the Toronto Stock Exchange on July 7, and we remain confident that this milestone will continue to support ERES in its growth, increasing liquidity and deepening investor base. Slide 5 highlights some key outtakes from the year ended December 31, starting with our investment activity, which picked up toward the end of the year, as I mentioned, with 3 portfolios acquired in the fourth quarter alone, a trend that we expect to continue as we navigate forward through 2021. Our strong liquidity position provides the backbone in this endeavor, reinforced by our most recent mortgage financing, which we executed in December at an interest rate of just below 1% for a 4-year term. All in all, we were able to conclude the year with approximately EUR 97 million in available liquidity, which is on hand for us to immediately deploy toward acquisition opportunities. This excludes cash dedicated to ongoing operational and capital expenditures. Our FFO and AFFO per unit both remained strong for the year-end December 31, 2020, at EUR 0.135 and EUR 0.121, respectively. While on one hand benefiting from acquisitions, both measures were negatively impacted from lower return earned on excess cash that we cautiously preserved earlier in the year amid the uncertainty surrounding the pandemic. In aggregate, the results are relatively stable metrics compared to last year. Slide 6 provides some statistics on our current residential portfolio. Average occupied monthly rents were EUR 853 as at year-end with a high and stable occupancy of 98.3%. Our turnover was 14.2% over the year, which is slightly higher than what we would consider as a relatively stable historical average of 12% to 13%. This was a result of higher than normal vacancy going into 2020 due to portfolios acquired toward the end of 2019, which drove higher turnover moving through Q1 2020 as we remedied that vacancy. Notably, our weighted average turnover was 3.4% for the fourth quarter of 2020, in line with 3.4% turnover throughout the same quarter in 2019. The ERES portfolio is well diversified by number of bedrooms, ensuring we meet demand for smaller units as well as families. You also can see that approximately half of the current portfolio was constructed since 1980, providing an average age of under 40 years, resulting in lower ongoing repairs and maintenance and driving higher asset values. To elaborate even further on the balanced mix of our properties that constitute our portfolio, on Slide 7, you can see that 40% -- over 40% of our current properties are located in the high-growth urban conurbation of the Randstad with approximately 25% directly located in the cities of Amsterdam, Rotterdam, The Hague and Utrecht. The rest of the portfolio is situated in smaller urban areas throughout the country. Notably, the dynamics of our diverse portfolio composition and its performance has been unaffected to date by shifts to deurbanization, a trend which many cities around the world are experiencing as a direct consequence of the COVID-19 pandemic and the widespread work from home and stay at home mandates. Further, approximately 35% of our portfolio is comprised of single-family homes, also known as Dutch row houses, a segment which represents an additional diversifying and unique contributor to our portfolio mix. Importantly, our suites continue to be nearly evenly divided between regulated and liberalized with a modest weighting toward liberalized, providing balanced growth potential in rents as well as the opportunity to liberalize more suites. On that note, a number of regulatory developments recently have been proposed by the Dutch government in response to the shortage in affordable and mid-market housing, such as cap rate -- such as a cap on indexation for liberalized suites, the prevention of buy-to-let for liberalized suites and the cap on points for the purpose of presenting -- preventing regulated suites from becoming liberalized suites too rapidly. However, there is no certainty as whether or when the aforementioned proposed legislation may be adopted by the government. In addition, for 2021, the government recently announced the maximum annual rent increases for regulated properties at 0% as an additional measure to support the Dutch people withstanding the COVID-19 pandemic. This parameter will not apply to liberalized rents nor rent uplift on turnover of regulated flats or CapEx-driven increases, all of which are significant drivers of ERES's rental growth. In light of these legislative developments, it is important to reaffirm that ERES already has been operating within a complex regulatory regime. And we'll continue to capitalize on this experience going forward, a competence which is increasingly becoming more important. Given the uniquely diverse composition of our balanced portfolio between urban and suburban, regulated and liberalized and across single-family and multifamily, we are positioned well to continue operating efficiently and productively within the Dutch regulatory system and deliver top line rental growth in the range of 3% to 4%. To this point, we self-imposed a cap across our portfolio rental index during 2020, resulting in a weighted average indexation of 2.4%. Notwithstanding an indexation increase lower than originally envisioned, we still met our growth target with a 3.6% increase in AMR year-over-year due to continuing strong performance on turnover rental uplift and CapEx investments, including converting regulated units to liberalized suites. That brings us to Slide 8, where I can provide a further update on the Dutch government's response to the COVID-19 pandemic to date. The substantial government assistance programs enacted since the beginning of the crisis continue in full force. Although numerous social restrictions have been extended or recently enacted to combat the second and third waves of COVID-19, the government support measures equally have been extended to sustain the economy and the people of the Netherlands. With their proactive response, the Dutch government has been able to mitigate as much as possible the adverse impact of the outbreak. Combined with strong market fundamentals and the underlying economic stability inherent in the Netherlands, unemployment has remained low, evidencing the effectiveness of these response efforts, the ongoing resilience of the economy and the robustness of market dynamics throughout the country. And with that, I will now turn the call over to Scott.

Thank you, Phil. As you can see on Slide 10, our operating results continued to improve, and our performance remains strong throughout 2020 despite the challenging circumstances. Our solid performance this year was driven by strong rental growth, up 68% since the prior year, an especially impressive outcome in the context of this pandemic. The increase in attributable -- is attributable to contributions from acquisitions as well as higher monthly rents and occupancy on stabilized properties. Net operating income has followed suit, increasing by an even higher 69% compared to last year, with the additional positive impact provided by proportionately lower property operating costs. In aggregate, this has resulted in an increase to our NOI margin from 75.6% last year to 76.2% this year, quantitatively reflecting our operational strength, which Phillip has been highlighting thus far. FFO and AFFO increased by 63% and 65%, respectively, compared to last year. FFO per unit decreased slightly compared to 2019, predominantly as a result of the cash drag from our above-average liquidity reserve, which we maintained throughout most of 2020 in response to the uncertainty of the COVID-19 pandemic. Although also negatively impacted by this, AFFO per unit increased by 0.001 due to the overriding positive impact to our accretive acquisitions since prior year. And we have great confidence in our ability to positively and more robustly grow our FFO and AFFO per unit in 2021 and beyond. And it is on this positive note that I'll pass the torch to Stephen Co as the new CFO of ERES. Although this will be my last conference call as part of the ERES team, I look forward to continuing to support its bright future in my capacity within the CAPREIT partnership. I've greatly enjoyed the ERES journey so far and truly believe in the ERES story. I have confidence Stephen Co will do a great job in his new role, and I thank Phillip for our strong partnership. Stephen?

Thanks, Scott. As detailed on Slide 11, our operating metrics have not only withstood the challenges of this unprecedented year, but have, in fact, improved since last year. As mentioned by Phillip previously, our residential suite count increased by 7.4% driven entirely by property acquisitions in only the last 4 months of the year. Residential occupancy increased to 98.3% and as at December 31, 2020, up from 97.2% at this time last year, which evidences the effectiveness of our property management through a focused minimization of inherited vacancy. Occupied average monthly rents on our stabilized portfolio increased by 3.7% compared to last year. The result of contractual indexation, turnover and conversion of regulated suites to liberalized suites. Net operating income on our stabilized portfolio similarly increased by 3.8% during the year, driven primarily by the higher operating revenues from the increased AMR and further complemented by lower property operating costs as a percentage of revenue. Notably and particularly in the context of the COVID-19 pandemic, ERES continued to collect residential rental revenue throughout the year at a rate consistent with its historical average. Our 2 office properties also provided stable and consistent cash flows. This collection profile was underpinned by operational focus on the process itself, which allowed ERES to materially lower its aggregate AR balances over the course of 2020. Our accounts receivable from residential tenants decreased by 9.1% on an absolute basis compared to last year, an achievement especially noteworthy given the circumstances of 2020, and even further magnified by the increase in the size of our portfolio as at December 31, 2020 compared to this date last year. Our liquidity position continues to support our business endeavors and remains conservative and strong as at December 31, 2020, as you can see on Slide 12. Amid the unpredictability of the capital markets, ERES was able to maintain its debt to gross book value within its target range of 45% to 50%; lower its weighted average mortgage effective interest rate by 3 basis points as a result of having recently secured financing for its 2020 acquisitions, in aggregate, at a loan-to-value ratio of 55% and with an interest rate of only 97 basis points, reflecting the persistently low financing rates in the European Union; and manage the average term to maturity of its mortgage portfolio to a conservative 4.4 years, which includes the impact of our most recent mortgage financing. Compounded the above with ample available liquidity of EUR 97 million as at December 31, 2020, excluding cash on hand dedicated to ongoing operational and capital expenditure requirements, we have immediate capacity to acquire over EUR 240 million in assets. The strength of ERES's liquidity position not only supports future growth, but also assists distributions. To that end, ERES is pleased to announce an increase in its annualized distribution rate from EUR 0.105 per unit to EUR 0.11 per unit, effective immediately and applicable for our next monthly distribution in respect of March 2021. Slide 13 provides more detail on our staggered mortgage portfolio, with the nearest debt maturity not occurring until December 2022. You can see that our recently added mortgage with its 4-year term maturing in 2024, balances well within our existing profile. In addition, the majority of our mortgages are non-amortizing. As we continue to grow, we will ensure this smooth maturity profile in order to reduce renewal risk. Thank you for your time this morning. And I will now turn things back to Phillip to wrap up.

Thank you, Stephen. In summary, although this extraordinary year was fraught with challenges, it provided ERES with the opportunity to prove the robustness of the core fundamentals in its primary market and the strength of its operating platform. It was a test as it was for many, and in this context, we are proud of ERES's strong performance throughout 2020 as we evolved safely, efficiently and ultimately matured beyond our years. The validity of our strategic direction and long-term objectives have been demonstrated, and we look forward to continuing in their pursuit. And in doing so, we will remain both proactive and cautious, resilient and ambitious and very much ready for the opportunities and challenges that are forthcoming and for many years to come. In this regard, we believe that 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 have 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 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] The first question is from Jonathan Kelcher of TD Securities.

Yes. Can you maybe just -- and I might have missed some of this, but go over some of the potential changes -- or near-term changes, I guess, to the regulatory rules in 2021?

Sure. And I'm guessing everybody on the call was probably in a race to ask that question. So the most important thing is dealing with what we know, and then there's dealing with what is potentially coming. And it also has to be viewed in the context of elections, national elections, which are going to take place on March 17. So a lot of what we may read can be political positioning, keeping in mind that the Dutch government is always a coalition government, and many of the different parties are now setting out their stalls of what they'll focus on in their mandate, if they're included in the coalition. But having said that, what we know now is that within the existing regulatory framework, there's been no change in any laws or any framework to date. The Ministry of Housing has announced that the regulatory parameters for indexation for the regulated units for 2021 will equal a 0 percentage increase. Historically at CPI-plus something and CPI-plus something else, depending upon what the income level is. But for the regulated units for this year, it's anticipated -- well, it's not anticipated, it's been announced that there will be 0 indexation, which would normally take place on July 1. It doesn't impact turnover uplift, it doesn't impact liberalized suites, and it doesn't impact CapEx investments that can drive value. There's also, over the past 12 months, and I think through various calls with you and others, we've highlighted potential other legislation where they may cap the contribution that the municipal tax value can make, to your point. There's been other muted legislation that they might try and put an indexation cap on liberalized suites. But none of that passed as of yet. It hasn't been brought into law. The Dutch cabinet is now currently suspended in advance of the elections. So it's not impossible, but it's unlikely that any of that legislation would move forward. And then we also have to see what the government looks like and what the construct of the coalition looks like and what their key mandates will be going forward. So what is clear now is there's been no change in law. There's been no change in the framework of the regulation. The Minister has just announced, as she normally does, the parameters for regulated indexation for 2021, which is 0 indexation for regulated suites. I mean, importantly, what does that mean for our top line growth, which I'm guessing would be the follow-up question.

Yes. You're doing my questions.

That's right. Our growth is driven by the indexation as well as turnover and capital investments. And if you look at 2020, it's a very good example of how robust our ability to drive rental growth is. Although it wasn't required, we self-imposed -- trying to be socially responsible and cognizant of the pandemic, we self-imposed a 2.6% cap on ourselves across all of our suites because that's what CPI was announced for 2020. The result of that was total indexation growth across our portfolio of 2.4%, but yet we were still able to drive total rental growth or AMR growth at 3.7%. And so even though we come in with a lower-than-anticipated indexation, we can still, through other measures and the performance of the portfolio, drive top line rental growth, very consistent with our range that we always give guidance on, of 3% to 4%. And so with the new pronouncement for indexation allowance for regulated being set at 0, we once again will anticipate indexation across the whole portfolio probably to be around 2%. But we still are very confident that we'll make up a significant portion of that, and we still envision for 2021 top line rental growth between 3% and 4%.

Okay. That is helpful. And just on the 0% for regulated, if you do spend CapEx, it can be higher than that. Is that -- am I getting that correct?

That is correct. The complex answer is if you spend it on turnover, then you can increase the number of points and you can go to the maximum point, as you would normally be able to. If you do it on the liberalized suite, you can take it to as high as the market will allow. If you were to do it with sitting tenants, then you have to basically, in good faith, agree what the new points are and what the new rental uplift would be. But it's rare that we do CapEx investments with sitting tenants.

Okay. So -- okay. That's fair. And then just, I guess, maybe related to it, just looking at the discretionary CapEx budget for 2021 on a per suite basis versus what you had for 2020. It's up quite a bit. Is that all tied in? Or just maybe provide a little bit of color on that.

That isn't really tied into us trying to incrementally make up rental growth. That is a function of going suite by suite and where we see the opportunity to -- a significant portion of that, as we disclosed, is in suite CapEx, which is largely investing and/or conversions. There is a little bit of catch-up in that versus our budget in 2019 and what we delivered. We under-delivered our CapEx largely because we were so acquisitive. In 2020, we didn't meet our CapEx budget either, simply because of the COVID pandemic and the ability to execute a lot of that program. So you are correct that the 2021 budget is significantly up on the prior year. That's all been very targeted. We've gone through it in great detail. It's all sensibly expected to be spent. But there still is the question of whether we actually can do that high level of volume, but we'd be very happy to do that level of volume because we think it's all value-add or intelligently defined capital expenditure.

Okay. So a lot of that would be dependent on turnover or some of it anyway?

Turnover, for example, or lockdown procedures of what you can and cannot do safely, et cetera.

The next question is from Kyle Stanley of Desjardins Capital Markets.

So there's a nice year-over-year decline in same-property OpEx during the quarter. I'm just wondering, could you elaborate on that a little bit, and maybe what drove it?

Yes. It's mainly due to -- if you're looking at Q4 of this year versus last year, we had -- proportionately as a percentage of revenues, R&M was slightly lower, and plus a bad debt expense. But mainly, it has to do with timing of expenses. If you noticed in Q3, our margin -- NOI margin was around 75.6%, and then it was up in Q4 of around 77%. So it's just a timing of expenses. But if you were looking at more of a forward-looking, I mean, it's always -- we provide that range, I would say, NOI margin around 76% on annual basis makes sense.

The other thing I would add, Kyle, and it connects in with your question and also with Jonathan's question. In connection with the pronounced parameters for regulated indexation, the Minister, in her announcement, her official published announcement, also recognized that this can have a meaningful effect on landlords. So as a mechanism to potentially offset some of that negative deviation, she has made available EUR 200 million that will be given back to landlords in a form of landlord levy relief. They have not yet defined how that will work or what that quantity of relief will look or how it will be applied. But again, there may be some margin uplift potential that we're not forecasting now but could be depending upon what the ultimate parameters and construct of that EUR 200 million give back in the form of landlord levy tax relief can be.

Okay. Great. That was actually my next question, about that -- about EUR 200 million. Yes, it's an interesting move coming out of the government, just given in the past, they've seemed kind of opposed to more restrictive rent measures like this. So yes, a bit surprising, but I get what you said, the political posturing ahead of the election. So that makes sense.

And again, the Minister, she's from the liberal party, which actually is the more conservative party notwithstanding its name. She has very much been a proponent of supply -- of a supply solution, encouraging the delivery of more supply. And again, a lot of that supply, they want to see coming at the affordable end, which generally is the housing association. So if you're limiting their growth, limiting their profitability, then you would consequently be limiting their proceeds and their ability to redeploy that capital into newbuild, new delivery of units. So again, she was very aware of that. It's in her statement. And that's why within her new construct, she's making this available. But again, we're unlikely to have more visibility on that until we get to the other side of the elections. But to your point, it is consistent that she has historically been against arbitrary rental regulations and very much more a proponent of finding solutions to deliver more supply.

Okay. Great. And then just the last one, I'm not sure if you have this on hand, but the rent increase on turnover for the full year was really healthy. It's almost 10%. Do you have the breakdown of the increases on turnover for the fourth quarter, by any chance?

It accelerated in the fourth quarter? Sorry, Stephen.

No, go ahead, Phillip. I can touch on it afterwards. Or...

Yes. I mean, I think that's another good point, is that, again, our ability to drive rental growth within the range that we consistently provide guidance range, in that 3% to 4% range, it is based upon the empirical data that we've been delivering consistently. Throughout the course of 2020 versus 2019, in each category, our rental uplifts were higher than the preceding year. And in Q4, that trend accelerated even more, such that the Q4 alone rental uplifts were above 12% compared to the 10% for the entire year 2020.

The next question is from Brad Sturges of Raymond James.

I guess from the transactional market point of view, does this essentially put a little bit of a hold or a temporary slowdown in some of the transaction activity you see until after the election? And like would some of the housing association essentially get maybe more impacted or would be a little bit more cautious in terms of pursuing asset sales at this stage?

I think the answer is a TBD. We anticipated, and it's turning out to be that, that there would be a slowdown in Q1 and potentially Q2 anyway. That's a result of the significant activity in 2020. There's various numbers published between EUR 7 billion and EUR 9 billion of total residential transaction volume. That's across newbuild, new deliveries, forward funding, forward purchases, et cetera. But the volume was up year-on-year. And in Q4, the volume was up dramatically. So people anticipated a slowdown coming into Q1 and potentially Q2. So we'll see if there's an incremental slowdown as a result of the indexation measure. I Wouldn't anticipate it because, ultimately, the pension funds, insurance companies continue to want to rotate their stock. They continue to want to move more into the newbuild, easier to manage assets. The housing corporations still need to transition their portfolio when they have liberalized -- or soon to be liberalized suites to sell them on so that they can take proceeds and redirect them into the affordable/regulated units. So the overall fundamentals, the imbalance, the requirement to deliver new units is still there. So we would expect to continue to see that rotation of stock from the insurance company's pension funds and housing corporations, which has historically been the biggest driver of volume for the assets that ERES looks at. But again, we anticipated Q1 to be slow and probably the beginning of Q2. So we just need to get a little bit deeper into the year before we see that tangibly, but we still remain opportunistic -- or optimistic that there'll be an opportunity to externally grow this year.

And does it change your thought process in terms of the REIT strategy? Like do you -- does the REIT look at a little bit more liberalized weightings in assets or portfolios in the short term? Or how does this regulatory environment maybe impact your thinking around acquisitions?

I don't think it changes it a lot, honestly. Our diversification, as we've highlighted today and previously, we have 45%, 55% regulated/liberalized. We have 40%, 60% Randstad/other. We have 55% -- or 65%, sorry, multifamily; 35%, single family homes. We think that's a very nice mix. That isn't a specific definition. But we think it works well. I think our performance in 2020 is demonstrating that, that's a very robust portfolio mix. And we want to continue to have that mix -- simply because regulated indexation might be flat this year, it doesn't mean we don't like that sector. You definitely see higher cap rates there, so higher yields. And the foregone revenue growth isn't forever forgone. It's only delayed. And the overall matrix or the cap is continuing to go up by inflation. That hasn't been adjusted. So even to the extent that you're not extracting that value this year, that will be value that we could extract in the future. So I certainly don't think it would cause us to shy away from buying regulated suites. And generally speaking, or directionally speaking, we would want to continue to maintain a good diversification, not inconsistent with where we are now versus liberalized/regulated, Randstad versus other and single-family versus multifamily.

The next question is from Matt Logan of RBC Capital Markets.

So in your letter to unitholders, you talked about a focus on acquisitions and that the REIT is monitoring opportunities elsewhere in Europe. Can you talk about what markets look attractive to you and the factors that you need to see to start growing the residential portfolio outside of the Netherlands?

Sure. And as we've said since the inception, it was always intended for ERES and CAPREIT to have this be a European platform, and that continues to be the medium-term strategy. And we've equally always said that we continue to see a very robust runway in the Netherlands, and we continue to. So I don't think it is an immediate accelerator of us looking elsewhere. But again, we do ensure that we make ourselves aware and look for opportunities. But we still very much like our primary market. To go outside, where would we go? You have the benefit of financing generally across Europe. We would be able to get consistent financings that we do in the Netherlands. Very attractive financing rates. So we would then have to look at the cap rates versus the growth profile and how that looks versus our existing portfolio and opportunities in the Netherlands. But the core geographies within Europe, we'd be very comfortable doing business, whether that be Germany, France, Belgium. Those are part of the core engine of Europe that has consistently, like the Netherlands, performed well. It's never too hot, it's never too cold. And those are the dynamics that we like. Most of those places have similar supply-demand dynamics, i.e., a shortage of housing. So we actively monitor them. But the dynamics of changing regulations or anything of that are not accelerating our view of looking beyond the Netherlands. It's simply, do we continue to see an opportunity to further grow in the Netherlands? And is there an opportunity outside of it that we think is more appealing or equally appealing?

Great color. And in terms of your near-term acquisition capacity, is there a target debt to gross book value level that you'd like to maintain given your current cost of capital? Or maybe where would you be comfortable taking leverage up to in the near term?