Killam Apartment REIT (KMPUN) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Killam Apartment Real Estate Investment Trust Second Quarter 2023 Financial Results Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session[Operator Instructions]this call is being recorded on Thursday, August 10, 2023. I would now like to turn the conference over to Mr. Philip Fraser, President and CEO. Please go ahead.

Thank you. Good morning, and thank you for joining Killam Apartment REIT's Second Quarter 2023 Conference Call. I am here today with Robert Richardson, Executive Vice President; Dale Noseworthy, Chief Financial Officer; and Erin Cleveland, Senior Vice President of Finance. Slides to accompany today's call are available on the Investor Relations section of our website under Events and Presentations. I will now ask Erin to read our cautionary statement.

Thank you, Philip. This presentation may contain forward-looking statements with respect to Killam's REIT and its operations, strategies, financial performance conditions or otherwise. The actual results and performance of Killam discussed here today could differ materially from those expressed or implied by such statements. Such statements involve numerous inherent risks and uncertainties. And although Killam management believes that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that future results, levels of activity, performance or achievements will occur as anticipated. For further information about the inherent risks and uncertainties in respect to forward-looking statements, please refer to Killam's most recent annual information form and other securities regulatory filings found online on SEDAR. All forward-looking statements made today speak only as of the date which this presentation refers and Killam does not intend to update or revise any such statements unless otherwise required by applicable securities laws.

Thank you, Erin. We are very pleased with our strong financial and operating results for the second quarter of 2023. Killam delivered FFO per unit of $0.30 in the quarter, a 7.1% increase from $0.28 per unit in Q2 of 2022. We achieved 7.9% same-property NOI growth across the portfolio, which included 7.8 same-property NOI growth in our apartment portfolio, 3.8% same-property NOI growth in our manufactured home community portfolio and 15.7% same-property NOI growth for our commercial properties. We ended the quarter with a 43.1% debt to total asset ratio, the lowest in our operating history and continue to focus on strengthening our balance sheet through our capital recycling program and the positive lease-up momentum on our recently completed developments. As we continue to capture the mark-to-market opportunities on new returns, we have exceeded our 3% to 5% NOI growth target in the first half of the year and expect to exceed 6% for 2023. Dale will now take us through our financial results, followed by Robert, who will discuss our ESG initiatives. I will continue with an update on our current and recent development and capital allocation strategy. I will now hand it over to Dale.

Thanks, Phil. Key highlights of Killam's Q2 financial performance can be found on Slide 6. Killam generated strong earnings growth in the quarter with net income of $114.5 million, a 66.7% increase compared to Q2 2022. This increase is primarily attributable to fair value gains on investment properties of $96.2 million, a direct result of revenue and NOI growth across the portfolio. June's average same-property apartment rental rates at June 30, 2023, $1,319, up 4.3% from a year earlier. Slide 7 highlights the consistent growth in Killam's average apartment rental rate with the portfolio's average rent up 26% from 5 years ago. Slide 7 also provides a summary of the age of the portfolio and the distribution of average rents by unit count. The impact of Killam's long-term strategy of developing and buying new assets is highlighted with 33% of Killam's apartment units built in the last 10 years and a total of 46% built in the last 20 years. As the chart on the bottom left of the page highlights our portfolio is well diversified from a rent range perspective. The top chart on Slide 8 breaks down the rental growth achieved on renewals and turns by quarter, reflecting the rent increase for tenants and leases renewed in the quarter and for new tenants who moved into a unit in the quarter. We're pleased to report continued momentum on rental gains with Q2 turns and renewals achieving a combined 5.5% rent growth. With rent control in place across 60% of our portfolio, we are capturing market rent rates when a unit turns. We realized a 14.7% increase on turns in Q2, our highest spread to date. We're seeing rental growth across the portfolio with our Toronto and Kitchener-Waterloo, Cambridge properties leading the pack followed by Victoria. Rent growth continues to be strong in Halifax and in our other Atlantic Canadian markets. Turnover levels are decreasing across the country for Killam and for all apartment owners. Our turnover was 22% last year, and we are anticipating our 2023 turnover to be around 18%. Slide 9 provides a summary of turnover by our core markets over the last 3 years. It highlights the range of turnover levels across the country, including how much higher it is in non-rent-controlled markets. Turnover in Alberta, New Brunswick and Newfoundland remained healthy, generally above 25%. Slide 10 shows our total same property operating costs, up 0.7% in the quarter, contributing to our strong NOI growth. Killam benefited from lower natural gas and oil pricing in the period, which offset almost all increases in water and energy costs. I'm pleased to report that natural gas costs in Nova Scotia and New Brunswick remained below last year's levels at this time. So we are expecting to see quarter-over-quarter savings in Q3 also. We recorded a 2.3% decrease in property taxes in Q2, primarily attributable to lower new run and PEI property taxes. The decline in property taxes in PEI is due to property tax subsidies to help offset the 0% rent control for 2023, and the decrease in New Brunswick was driven by a reduction in regional mill rates. General operating costs were up 3.2% in the quarter, a more moderate increase than we realized in Q1. Although we continue to see inflationary pressures, operating cost pressures appear to be moderating. As seen on Slide 11, our MHC properties had a solid performance in Q2, achieving 3.8% same-property NOI growth. Additionally, our commercial portfolio delivered an impressive 15.7% same-property NOI growth relating to increased occupancy of 94.7%, coupled with higher rental rates on renewals. Overall, with consistent performance in Q2 and following a strong Q1, we're forecasting to exceed our 3% to 5% NOI growth target with our -- with new guidelines increasing this target to over 6% for the year. On the balance sheet, we're pleased that our disciplined focus on reducing leverage have allowed us to achieve the lowest debt to total assets ratio in our operating history, ending the quarter with 43.1%. Our debt to normalized EBITDA continues to move in the right direction, ending at 10.9x at June 30, down from 11.21x at year-end. Please refer to Slide 12 for these debt metrics. We're focused on strengthening our balance sheet and reducing variable rate debt and have been meeting our internal debt reduction target. During the first half of the year, we successfully reduced the balance on our credit and construction facilities by $68.7 million, down 32% from $215 million at December 31, 2022. This reduction was achieved through the reallocation of funds from dispositions and from permanent financing placed on recently completed development. Subsequent to quarter end, permanent CMHC financing was placed on CITIC 66, further reducing our variable rate debt by another $57 million. Killam achieved the maximum points available for energy efficiency, eligibility under CMHC's MLI Select program at this property, enabling us to lock in permanent CMHC insured financing for full lease-up and at attractive terms. Based on our projected asset sale and debt financing program, we anticipate having the majority of our operating and construction lines repaid by the end of the year. Slide 13 shows our average apartment mortgage rates by year versus prevailing CMHC insured mortgage rates. Our mortgage maturities are strategically staggered to avoid overexposure in any 1 year. For the remainder of 2023, Killam has $102 million of mortgages maturing with an average interest rate of 3.25%. I will now turn the call over to Robert, who will discuss our latest initiatives outlined in our recently published ESG report.

Thank you, Dale, and good morning, everyone. In June, Killam released its 2022 ESG report outlining many of our sustainable initiatives since constructing our first LEED-certified property 10 years ago. We have identified numerous opportunities to reduce our carbon footprint, resulting in many positive outcomes that include conservation of resources and reduction in energy costs. In 2022, Killam reduced like-for-like greenhouse gas emissions 2.7% and our carbon intensity ratio by 6.7%, both from their 2020 baseline levels. As a result of this progress and to prepare for upcoming regulatory requirements, advanced by the task force on climate-related financial disclosure, better known by the acronym TCFD Killam adopted new long-term targets for 2023. Please see Slide 14. We are committed to reducing Killam's carbon intensity 15% by 2030, coupled with establishing formal greenhouse gas emission reduction goals using science-based targets by 2024. We recognize the importance of reducing Killam's carbon footprint and are using related cost savings from lower commodity consumption to further fund our initiatives. As part of our sustainability program, we are integrating smart building technologies such as building automation systems or BAS, as part of our preventive maintenance work, refer to Slide 15, please. To date, 19 of our properties have been upgraded to use the BAS central server connected to the properties. This enables our team to remotely monitor and diagnose a building's energy systems performance. Therefore, we can identify operational issues sooner with exceptional reporting and lessen the time and cost required to address problems. This reduces our greenhouse gas emissions as well since inefficiencies are identified sooner. Currently, we are integrating an additional 20 buildings for connection to our BAS server this year. The implementation of smart building technology and preventive maintenance measures have resulted in savings in our utility and repairs and maintenance costs across the portfolio. These expense management processes enable Killam to maintain its carbon reduction momentum while simultaneously improving operating margins. In Q2 2023, our overall same-property operating margin increased by 160 basis points to 64.5% for the quarter as part of our journey to prepare Killam assets for net 0 emissions by 2050, our operations team is working with consultants across the country on energy modeling, improved in design and longer term, save mechanical upgrades. As the building infrastructure approaches its end of life, we are modeling how and where we can replace old equipment with new, more efficient systems. Collaboration by Killam's engineering team with consulting engineers and architects helped identify suitable technologies and best practices for decarbonization. Implementation is achieved with coordinated effort across all departments, overlaying our operations, acquisitions, finance and sustainability teams. We have learned there is a strong correlation between Killam's largest greenhouse gas emitting properties and those requiring capital investments. Killam balanced the capital investment, return on investment and estimated greenhouse gas savings to realize optimal returns. Further, Killam considers the timing of these upgrades with mortgage refinancings to access CMHC programs that reward a reduction in carbon emissions. I will now hand you back to Philip to provide further details on our renewable energy projects and an update on our development and disposition activity.

Thank you, Robert. During the quarter, Killam invested $2.8 million in energy initiatives. In 2020, Killam started investing in solar energy production, and we currently have solar panels installed at 18 properties across Nova Scotia, PEI, Ontario and Alberta. Our current production capacity of 1,800 megawatt hours per year produces approximately 4% of our operationally controlled electricity, moving us closer to our goal of 10% by 2025. This year, we plan to invest $1.5 million in solar and currently have 5 additional solar projects underway that are expected to produce an additional 690 megawatt hours per year. We have also been active in rolling out electric vehicle charging stations. -- with 260 units installed across 39 properties. This number continues to grow, and we are committed to investing $1 million in EV chargers installations in 2023, targeting over 400 chargers across 50 properties with all our new developments being built to incorporate this technology. Killam has completed $82 million in dispositions year-to-date, with proceeds allowing us to reduce our floating rate debt. With completed dispositions in Ottawa, Halifax and Trelotan and 5 additional properties expected to be unconditional by September 2023, Killam plans to exceed its capital recycling target by the end of the year. Our development pipeline further supports our focus on improving our liquidity and capital flexibility, which saw 2 properties reached substantial completion subsequent to quarter end. Our $94 million of developments completed year-to-date is composed of the governor currently 33% leased, highlighted on Slide 20 and SYNC-66, currently 43% leased highlighted on Slide 21. Additionally, both properties are built with several advanced green technologies that will reduce operating costs, greenhouse gas emissions and our exposure to energy pricing. Our 2022 completed developments, the Kay and Latitude have similar features and are currently performing at operating margins over 70%. We have 2 active developments, the second phase of Nolan Hill highlighted on Slide 23 and the Keric on Slide 24. The second phase of NolanHill, a 3-building development in Calgary, is well underway and is expected to be completed by January of 2024. Killam holds a 10% interest in the second phase with a commitment to purchase the remaining 90% for $65 million upon completion. We expect to acquire the first building in September and the following 2 buildings in Q4. This will add an additional 234 units to our Alberta portfolio. The carat, which is expected to be completed in the first half of 2025 will add 139 units adjacent to our existing commercial property in Waterloo. Looking forward, with Canadian's current immigration target of approximately 500,000 individuals per year, Killam recognizes that development of new housing is a key factor in solving the housing crisis. Our development pipeline remains a fundamental component to our growth strategy, distinguishing us from our peers and allows us to grow our portfolio in strong markets. In 2022, Halifax was the second fastest-growing region in the country. And as such, our housing starts must keep pace. Killam is currently working on long-term planning for large redevelopment sites in Halifax and Waterloo, where additional density can be achieved through the planning process with minimal disruption to our existing tenants. To conclude, we are very pleased with our Q2 performance. I would like to thank our employees for their hard work and dedication. We are optimistic for the future and we'll continue to execute our priorities and create value for all of our unitholders. Thank you. I will now open up the call for questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session [Operator Instructions]. First question comes from Jonathan Kelcher at TD Cowen.

First question, Phil, just on the 5 unconditional or 5 properties you expect to be on conditional by September. What's the rough dollar amount and number of units on those?

Well, again, understanding that they are not unconditional, so they're still in the due diligence period. But it would be roughly about $80 million and maybe up to between 500 and 600 units.?

In your mostly East Coast or Eastern Canada?

Yes, mostly East Coast, if not, well, the largest percentage of it, for sure.

Okay. And you would -- are you looking at buying any new assets, maybe recycling some of the proceeds into that? Or just Nolan Hill kind of covers?

Nolan Hill is primarily the largest asset that we're looking at.

Okay. And then, Rob, on the BAS, -- is that something that you guys will eventually roll out to all properties? And is there any sort of like is there -- how much is the cost to your property or however you guys look at it?

We will roll it out throughout the portfolio and what it costs, it depends on the buildings. Some are older, some are newer. So it really is customized each property. But we're seeing benefits from it, and it makes perfect sense 250 buildings. It's difficult to do without automation.

Yes, correct. I agree. And then just lastly, Dale, on the Civic 66, what rate did you get on the CMHC financing?

Was 4.34 for 10 years.

The next question comes from Mike Markidis at BMO Capital Markets. In.

Dale, I think you mentioned that rent growth that you were seeing was largest in Toronto,Cambridge and Waterloo. And maybe just confirming that point and then maybe dovetailing on that, if you could talk to what you're seeing in terms of market rent growth, whether it's steady pace moderating in Halifax and New Brunswick please?

So I would say moderating to accelerating in Halifax. And I mean it's -- we're not seeing it go down on a market rent perspective. I'd say when I think of the last couple of quarters, we've been able to achieve that. So and it depends on the market, but stable to accelerating.

Okay. Great. And then obviously, there's a lot of ability and volatility in your op cost line and no one's got a great crystal ball, but how do you guys think of or do you think of what sort of the revenue growth profile on a same-property basis of your portfolio looks like next year?

Well, I think that we're pretty optimistic that it will accelerate next year because when we look at the acceleration we're seeing throughout this year, and you've got to think out 12 months, how that rolls. So that's going to be a positive. And with the 5% renewal rate in Nova Scotia compared to 2% and looking at the number of units we have, those 2 things alone should lead to stronger rent growth next year.

Okay. Great. Phil, you've been really successful on your asset sale program. So might say more successful on a relative basis than perhaps some of your peers. I was wondering if you had any thoughts as to why you've been able to act so quickly and what's driven your success versus -- I mean, we've heard some commentary from others that financing is quite challenging and that maybe walking back a little bit from the capital recycling story. So maybe you could just provide some thoughts on your success there.

I think that there's -- from our point of view, we've never been a seller. So the fact that there -- and there is a larger group of emerging landlords in Atlantic Canada. And I would like to believe that if we put a property for sale, the fact that we've owned it for a long time relative to the condition of it, the quality of the tenants that there is quite an attraction. And for many years, we've always had inquiries do you want to sell something. If you do, let me know. So I think there's been a bit of pickup demand from our ownership -- but that aside, there is a very positive look for the rental market in Atlantic Canada. And basically, we're happy. And now our deals hard to close, absolutely. The interest rate environment is not helping. The lack of basically services relative to do an environmental work is there's a shortage, which is prolonging some of these deals. But we're willing to work with the folks that we are engaged with to sort of dispose of these assets.

Okay. That's helpful. And last one for me before I turn it back. You've got a good long-term development runway in your portfolio, cost of capital and other factors have obviously slowed the start process thus far hearing that, perhaps there may be some demand from institutional players out there to participate in developments? Is joint venturing to help facilitate the start of your development pipeline, something that you would consider or explore at this point?

Well, again, I know the industry as a whole continues to look for other sources of capital. Partnerships are great. I mean, we have partnerships today -- but at the same time, where we are, we think we can grow right now on our own balance sheet, especially with the recycling of a few properties. This is a huge sort of influx of capital that we can recycle. And if we are going to take that money and eventually put it into the ground with the next development or the one after that, and then the amount that you tend to spend the first year or so before you go into your construction line is very manageable at this level. So right now, we're not looking at it very seriously, but we always would never turn down the opportunity to talk to somebody.

Okay. I mean obviously, you've got a target for this year, but if the market doesn't change, would asset sales still be on your priority list. in 2024?

I think I've said a couple of times before, on a go-forward basis, we will always look to review and sell assets into the future. This will be part of what we do.

The next question comes from Kyle Stanley at Desjardins.

Maybe just going back to John's question, just on acquisitions. I know obviously your focus, as you mentioned, is Nolan Haile. But I'm wondering, are you actively underwriting new opportunities in the market right now? Maybe what are you seeing out there? And at what point do you maybe start to become more offensive with your capital going forward as I think, Dale, you mentioned in your prepared remarks that by year-end, you hope to have most of your variable rate debt dealt with?

We are not actively underwriting any deal that has been presented by any of the brokerage houses on a marketing basis across the country. We are looking at them just to form an interest sake to see where the market is. But right now, like I said, we're concentrating on our development side, we're concentrating on the disposition of a number of assets. We're spending way more time looking at the development deal flow and how to accelerate some of these projects to get you to the point of being able to go into the ground. And then the other part of this equation is the amount of energy and time it takes to even get a current costing on some of the projects. And then the third part of it is the long-term larger development play we have in a number of locations where we can add significant density like the West Mountain Plaza and Waterloo, that's taken up a lot of our time. Now if there happens to be a little house next door to one of these development sites yes, we're going to buy it, but it's a very small one-off adding to the land plate.

Okay. No, I think that makes a lot of sense. You do have a lot of opportunity in the existing portfolio. Maybe next, just today, obviously, again, talking about reducing the variable rate debt exposure. Is that still your best use of proceeds? Just looking for maybe thoughts on potentially using the NCIB a bit more as we go forward through the year?

Yes. Right now, it is. I mean you're talking -- there's no secret, it's gone from essentially 2% up to about 7% and if we can quickly reduce that line of credit, our acquisition line, then we're going to be in really good shape from a liquidity point of view, from a debt leverage point of view and from just pure flexibility to look at future opportunities.

Okay. Fair enough. And then just the last one. Just looking for your thoughts on maybe the expectation for stabilization at each of the governor and Civic 66 more for guess our modeling purposes?

Sure. So as always, during the lease-up period, there will be a bit of a drag as we're no longer capitalizing interest. So I'm sure you're aware of that. But looking forward, when we look at those 2 combined from a FFO perspective, we're probably about a $1.5 million stabilized from an NOI perspective, we're probably 4% to 4.5% stabilized for those assets. Probably closer to the Perfect.

Next question comes from Matt Kornack at National Bank.

Just a follow-up to Kyle's questioning there. In terms of timing, was there any NOI attributable to either the Governor or Civic 66 positive or negative in Q2?

No, it actually didn't move into -- it still was in IPC until July 1. So we've just moved it into investment properties. And looking forward to the rest of the quarter, it will be -- we expect negative in the -- for -- until probably the end of this year.

Okay. And then in terms of stabilized occupancy spring leasing season? Or do you think you'll stabilize it in advance of the spring...

On both of them?

Yes. I guess the government..

Yes. The government is a little bit different. I think with CPIC 66, we've got 73 leases at 169 sites, not sites units leased. We would be optimistic speaking, that we should be almost full by the end of the year.

That's helpful. And then just with regards to the market rent growth question, next year, at least in Nova Scotia, you do get to go to 5% on renewals. Do you think that 5% represents kind of market rent growth, so the mark-to-market potential will stabilize at least in that province? Or do you still think that market rent growth is expanding at above that? And then I guess on turnover, how are you thinking about suite renovations at this point in terms of driving kind of above that number?

I understand your question, the 5%, I mean, just that's not getting us, I don't think, close to market rent. So I think we're going to continue to see lots of opportunity on turn. -- even after that, we get that 5% bump. I think that those suite renovations that there's still lots of opportunity there, and we're looking at it as market rents are increasing. And what we see is that the ability to really move those rents and kind of change the value offering of those units, it continues to make sense. So I think it's reasonable to expect similar levels to what we've done this year when we look at repositions beyond this year.

Yes, makes sense. And then last question, just with regards to supply. I mean, the population growth that you've had at East is pretty staggering. Has there been a supply response at this point from kind of the local development contingent -- or is it facing challenges like elsewhere in terms of just putting product up, getting -- making the numbers work, et cetera?

I don't think it's accelerating at this time. So forecast is for roughly 6,000 units to come online over the next 8, 9 months. And I think that, that's going to hold steady for the foreseeable future. The interest rates continue to rise, fewer builders will show up, and there is tremendous demand. That's what we have to find that balance so they can work together.

The next question comes from Gaurav Mathur at IA Capital Markets.

Just one quick question. Phil, to your earlier comments about the buyer pool increasing as you're looking to dispose assets. Would it be fair to say that the weather pool is also increasing at the same time? And how is that affecting the bid spread as these assets come to market?

Sorry, I didn't catch the last little bit of the buyer pool that you -- which was framing your question. Could you repeat that, please?

Of course. My question is, as you see the buyer pool increase, are you also seeing an increase in the vendor pool? And how is that affecting the bid-out spread for the assets that come to market?

Okay. I mean that's a good question. I don't actually see a lot of other assets for sale in Atlantic Canada.

Okay. And what would you say about the bid-ask spread at the moment? Has that started to narrow a bit? Or is it mostly the same as you've seen through the start of the year?

I think it's the same. I think a lot of the owners, if I was to go knock on the door and say, "I'd like to buy that asset, there's quite a spread of what I pay versus what they think it's worth.

[Operator Instructions] next question from Sairam Srinivas at Cormark Securities.

First, just going back to got a fine question in your comment on the dispositions. Just looking at the profile of these buyers, can you comment on the kind of buyers you see out in the market institution was in retail? And how have you seen that evolve over the last 12 months?

Well, I think really the only comment is that there the -- it's a combination of older, smaller, well-established owners looking to acquire because they've been able to sort of basically retain a lot of their earnings and have the cash and the willingness to continue to increase. And then there are sort of the newer entities that have their own access to capital, and they want to sort of grow in this region. So it's a combination of that. Obviously, it's not our peer group, the other publicly traded REITs. Institutional, right??

The next question comes from David Chrystalcat Echelon Capital Markets.

Just quickly on the upcoming Nolan Hill acquisition. Can you comment on expected yield and how that has changed given rent increases over the course of -- since locking in the purchase price?

Yes. I mean, good question, and we're not going to say exactly because we're just starting to lease. But the question itself, it really is about how much it has gone up since we did agree to purchase this and start to build this basically 1.5 years ago. So if we had modeled this the pricing around a 5%, it has gone up substantially since that time. It's going to be -- we'll be able to give you really color on it third quarter as we basically close and start the leasing of what the market is out there, but it's up substantially since we did our underwriting.

Okay. Fair. And on your same property NOI target, obviously bumped it up to 6%. You're already trending year-to-date north of 7%. Do you see any risk to that 7% coming down? Or any risk on the OpEx side in the back half of the year? Or is the over 6% really a kind of open-ended talk?

I think that's a good way to look at it. I mean we think that probably 2% to 2.5% kind of on the expense side, it's probably right now of what it's looking like, but with the continued top line growth. I think we -- we feel very confident that with the over 6.

Okay. And then maybe last one on the mark-to-market upside, I mean it's been growing since the start of the quarter. It's now in the, I think, 25% to 30% range. Is this a good indication of where we should expect lift on turnover to trend? It's obviously hitting records and rising rapidly, but should we expect to keep seeing it trend higher?

I think that's reasonable. It's hard to get the full number because it all depends on where the units turn. So when we're looking at the weighted average mark-to-market, certainly, some of those markets we talked about in Ontario have some of the highest, but yet the lowest turn. So it just depends on where those units are turning. But the trend that we've been presenting, we think can continue in terms of the high -- the increasing on turn.

There are no further questions. I will turn the call back over for closing comments.

At this time, I would like to thank everyone for listening and asking questions today. And we look forward to the third quarter conference call in November. Thank you.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.