Minto Apartment Real Estate Investment Trust (MIUN) Earnings Call Transcript & Summary

Good morning. My name is Pam, and I will be your conference coordinator today. At this time, I would like to welcome everyone to the Minto Apartment REIT 2022 Third Quarter Financial Results Conference Call. [Operator Instructions] Before we begin, I would like to remind listeners that certain statements about future events made on this conference call are forward-looking in nature. Any such information is subject to risks, uncertainties and assumptions that can cause actual results to differ materially. Please refer to the cautionary statements on forward-looking information in the REIT's news release and MD&A dated November 8, 2022, for more information. During the call, management will also reference certain non-IFRS financial measures. Although the REIT believes these measures provide useful supplemental information about its financial performance, they're not recognized measures and do not have standardized meaning under IFRS. Please see the REIT's MD&A for additional information regarding non-IFRS financial measures, including reconciliations to the nearest IFRS measures. Thank you. Mr. Waters, you may begin your conference.

Thank you, Pam, and good morning, everyone. I'm Michael Waters, Chief Executive Officer of Minto Apartment REIT. I'm joined on the call today by Julie Morin, our Chief Financial Officer; and Jonathan Li, our President and Chief Operating Officer. I'll begin the call by providing an overview of our third quarter results as well as other corporate developments. Julie will review our financial results in detail, and Jonathan will discuss our operating performance and growth initiatives. I'll conclude with our business outlook, and then we'll be pleased to take your questions. Our business momentum continued into a seasonally robust third quarter, and we delivered strong financial results. Like many REITs, our third quarter was relatively quiet from a transaction perspective, and our strong performance was a direct result of our talented operations team and our best-in-class urban portfolio. Our results were also supported by growing demand for urban rental housing, which is a result of rising interest rates, a growing housing affordability gap, increasing integration, strengthening rental demand from students and a noticeable return to downtown living. This was easily our best quarter since the onset of the pandemic. Average monthly rent for the same property portfolio increased 4.2% year-over-year to $1,720 per suite. Average occupancy increased to 96.2% compared to 92.9% in Q3 last year. We achieved that increase even though we significantly reduced leasing promotions due to rising demand. At the end of the quarter, occupancy was 97.4%. Year-over-year NOI for the same property portfolio increased by 13.3% and NOI margin for the same property portfolio improved by 200 basis points to 64.1%. We negotiated 574 new leases in the third quarter and achieved a gain of 14.5% over expiring rent. This was the highest quarterly gain the lease we've generated since the onset of the pandemic and the second highest in the history of the REIT. Market rents increased in all of our markets. We estimate that the embedded gain-to-lease potential in the portfolio increased to 12.1% at the end of Q3 or approximately $16 million on an annualized basis. That compares to 6.6% or $7.3 million a year ago. We generated AFFO growth in the quarter of 28.2% compared to Q3 last year. And AFFO per unit increased by 15.1% year-over-year or 10.2%, excluding the impact of a onetime insurance recovery received in the third quarter. We continue to make good progress in our repositioning program in the third quarter as well. We renovated 75 suites, generating an average annualized return on investment of 9.4%. These low-risk investments improve asset quality, reduce repair costs and drive strong growth in rental revenue. I have a few additional updates to go over on Slide 4. As we announced in September, Julie Morin will be transitioning back to the Minto Group as Chief Financial Officer following this reporting period. Edward Fu will take over as CFO of the REIT. Eddie is currently the REIT's Vice President of Finance and has done a terrific job in his role. He's been a valuable member of the Minto team for more than 8 years, and I'm confident that he is the right choice for CFO. Eddie, along with Jonathan Li, will be full-time employees of the REIT. And yesterday, we announced some more good news. As you probably saw in our news release, the Board of Trustees has approved a 3.2% increase in the REIT's monthly distribution. The annual distribution increase amounts to $0.015 per unit and will be payable beginning with the November distribution. The REIT has now increased distributions in each of the 4 years following its formation. This is another measured increase that highlights our cause of financial performance and our confidence in our growth strategy and business outlook. It's important to note that while regularly increasing distribution is a priority for the REIT, we're also committed to maintaining a strong balance sheet and conservative AFFO payout ratio. Finally, in October, we released the REIT's 2021 ESG report, which included the results from our 2022 Global Real Estate Sustainability Benchmark, or GRESB, assessment. We're proud of the overall results. Our GRESB score was 80, an increase of 10 points over the prior year score and places us in the top quartile among 16 North American peers. In addition, the REIT received a score of 93 and a Level A rank in the GRESB Public Disclosure evaluation, ranking first out of ten in its comparison group. These results demonstrate our ongoing commitment to ESG initiatives. Julie will speak more of this shortly. Overall, we're very pleased with the quarter and believe that we're in a strong competitive position as market conditions continue to strengthen. In addition, we're working hard on a number of initiatives to drive value for unitholders, including achieving operational efficiencies, refinancing variable rate and mortgages to mitigate interest rate volatility, continuing to execute on our existing developments, fulfilling our convertible development loan commitments and advancing repositioning projects. We're confident that our strategy will drive continued growth in revenue, NOI and AFFO per unit despite the current elevated interest rate environment and inflation. I'd now like to invite Julie Morin to discuss our third quarter financial and operating performance in greater detail. Julie?

Thank you, Michael. Turning to Slide 5. We reported same-property portfolio revenue of $34.3 million in Q3 2022, an increase of 9.8% compared to $31.2 million in Q3 last year. The increase was mainly due to higher occupancy, higher average rents and reduced amortization of promotions. Total portfolio revenue was $37.8 million, a year-over-year increase of 21.1%, reflecting higher rents and occupancy, reduced amortization of promotions and the 3 property acquisitions completed subsequent to Q3 last year, with Hill Park in Montreal, Niagara West in Toronto and The International in Calgary. Same-property portfolio NOI in the third quarter was $22 million or 64.1% of revenue, an increase of 13.3% from $19.4 million or 62.1% of revenue in Q3 last year. Total NOI was $24.2 million or 64% of revenue, an increase of 24.8% from last year. The higher NOI this year mainly reflected increased revenue, partially offset by higher operating expenses. FFO in Q3 2022 increased 25.7% year-over-year to $15.7 million compared to $12.5 million in Q3 2021, mainly due to the positive NOI variance. AFFO increased 28.2%, $14 million or $0.212 per unit from $10.9 million or $0.184 per unit last year. Higher AFFO mainly reflected a higher FFO, partially offset by an increase in the maintenance capital expenditure reserve from the 3 properties acquired subsequent to Q3 2021. And as Michael noted earlier, AFFO per unit increased 10.2% year-over-year after excluding the impact of a onetime insurance recovery. The AFFO payout ratio was 55.9% compared to 61.7% in Q3 last year. Average monthly rent per unfurnished occupied suite in Q3 2022 was $1,720 for the same property portfolio and $1,714 for the total portfolio, representing increases of 4.2% and 3.8%, respectively from last year. Average occupancy was 96.3% for the same property portfolio and 96.2% for the total portfolio. These represented significant improvements from 92.9% in Q3 2021. I'll now turn it over to Jonathan Li to review our operating performance and growth initiatives. Jonathan?

Thank you, Julie. I'll start with average monthly rent and gain-to-lease on Slide 2. You can see the positive upward trend in both leasing gains and average monthly rent on the upper chart. Average monthly rent surpassed $1,700 in Q3 2022 and has increased more than 20% since the formation of the REIT. Gain-to-lease was negatively impacted by the onset of the pandemic in the spring of 2020. Our realized gain-to-lease continues to improve as rental market dynamics continue to be favorable, with realized gains of 14.5%, marking the fourth sequential quarterly improvement, which is notable in a seasonal business. On the lower chart, we break out rent by geography. Despite recent market rent increases, our rental pricing remains a very attractive alternative compared to renting a condo, buying a new home or owning an existing home with a variable rate mortgage. For example, in Toronto, our rental rate per square foot is $2.62, which is 25% lower than renting a condo based on market data from Urbanation. In addition, the carrying cost of a $500,000 mortgage would be approximately $2,900 per month using a 5% interest rate and a 25-year amortization. I'll now dig into the gain-to-lease performance in greater detail on Slide 7. Beginning with the upper chart, which breaks down our realized gains in the third quarter, we signed 574 new leases in the quarter following REIT turnover, up from 555 new leases in Q3 last year. We generated double-digit gain-to-lease in all of our markets, including an impressive 15.5% gain-to-lease in Toronto. The average rent on new leases increased by 14.5% from $1,675 to $1,918. This was the second largest quarterly gain in the REIT's history and it resulted in an annualized incremental revenue gain of approximately $1.4 million. Turning to the embedded rent portfolio gain-to-lease potential on the lower chart, we believe we can generate approximately $16 million of annualized incremental revenue by bringing rents to market levels, representing potential gain-to-lease of 12.1%. By comparison, we estimate gain-to-lease potential of $6.6 million or 7.3% at the end of Q3 2021. I'd now like to review occupancy on Slide 8. As rental demand has improved over the last 12 months, our move-ins has exceeded move-outs contributing to higher occupancy. We had 691 move-ins during the third quarter compared to 562 move-outs, a net increase of 129%. Over the last 4 quarters, there was an increase of net move-ins of 302 despite significantly reducing the use of discounted promotions, which were an important tool to drive occupancy during the pandemic when occupancy was lower. Turnover in Q3 was consistent with our turnover in Q2. However, we do expect a slight slowdown in turnover going forward as the gap between sitting rents and market rents widened as well as due to seasonality. Moving to Slide 9. I want to review our Furnished Suites portfolio performance. Reduced business travel during the pandemic severely impacted demand for the furnished suites, but as travel restrictions were removed and demand from corporate users and the film industry recovered, furnished suite demand rebounded as well. In the third quarter, average monthly rent was $5,261, an increase of more than 30% from Q3 last year, and occupancy was 91.9%, an increase of 560 basis points from Q3 2021. Our furnished suite count now stands at 189 suites, a reduction of 23% from Q3 last year and is close to our strategy target. We are very pleased with the strong performance of our furnished suite offering in Q3. However, it is important to note that Q4 is seasonally a slower quarter for furnish suite. Slide 10 breaks down our quarterly operating expenses for both the Same Property Portfolio and the total portfolio. Property operating costs in the third quarter increased due to higher labor costs, fueling staffing vacancies and higher insurance costs. We are working hard to minimize operating costs, which are rising industry-wide in the current environment of high inflation. Property taxes for the Same Property Portfolio increased marginally compared to Q3 last year, reflecting higher assessments in rate. Large percentage increase in utilities expenses was mainly attributable to a substantial increase in natural gas rates, recognizing that typically our natural gas costs represents a smaller portion of our overall cost structure in the third quarter. On Slide 11, you'll find a summary of our repositioning activities. We renovate at the moment a total of 75 suites in the third quarter or 56 at the REIT's proportionate share at an average cost of approximately $55,000 per suite. The average annual rental increase following repositioning was $5,150 per suite or $370 per month, which generated a simple return on investment of 9.4%. We have 2,024 remaining suites to reposition under the current program. We expect to reposition approximately 40 to 50 in the fourth quarter, subject to turnover. We repositioned a total of 218 suites in the first 9 months of the year. On Slide 12, we have 8 projects in our pipeline, 5 of which are in active development and one stabilized. 5 of them are convertible development loan projects that include exclusive purchase options upon stabilization and 3, our direct investments in properties we own. These projects are located in our target markets and have the potential to increase the REIT suite count by over 2,300 suites or 28% from our current level. On Slide 13, 14, you can see recent photos of each of the projects in active development, and we'll talk about a few of them. Beginning with Fifth and Bank, this mixed-use residential and retail property in Ottawa's part of the Glebe neighborhood is stabilized. It is currently 100% leased and is not subject to rent control. Minto Group has agreed to extend the REIT's option to purchase the property to June 30, 2023, and extend the maturity of the convertible development loan to July 31, 2023. At this time, the REIT has not yet made a decision regarding the exercise of the purchase option and any decision will be based on market conditions and other factors at that time. Lonsdale Square in North Vancouver has been topped off and is nearing completion. Market rents in the North Vancouver north continued to increase with rental buildings in the area, achieving rents of approximately $5 per square foot. Land leasing of the 113 suites is expected to begin in the first quarter of 2023. Once stabilized, the REIT will have the option to purchase the project at a 5% discount to appraise value. Stabilization is expected to occur in Q4 of 2023. Finally, at our Richgrove property in Toronto, we are very proud to be building 100 affordable suite as part of this 225-suite offering with the help of our federal and municipal partners. This is an exciting example of developing new affordable housing for the betterment of our local community. We anticipate stabilization in the second quarter of 2026. I'll now turn it over to Julie to review our debt financing and liquidity.

Thanks, Jon. Turning to Slide 15. We are committed to maintaining a conservative leverage ratio and a balanced debt maturity schedule. As the chart shows, debt maturities are highly manageable through 2027. As of September 30, 2022, the weighted average term to maturity on our fixed rate debt was 4.48 years with a weighted average interest rate of 2.9%. Approximately, 78% of our debt with fixed rate and 65% with CMHC-insured lower cost debt. I also want to note that we assumed approximately $108 million of floating rate loans on the acquisitions of Niagara West and The International in the second quarter of this year. We are actively pursuing long-term CMHC-insured financing to refinance these properties with funding expected before year-end. Closing these loans would increase proportion of fixed rate debt to 88% and the amount insured by CMHC would increase to 72%. Total liquidity was approximately $145 million at the end of September 2022, and Debt-to-Gross Book Value was 39.9%. Regarding our capital recycling initiatives, the sale of our Edmonton portfolio continues to progress, and we hope to provide an update next quarter. Moving to Slide 16. We have now owned Niagara West and The International for slightly more than 6 months. Both properties are performing very well for the REIT. Occupancy at Niagara West and downtown Toronto increased to 98% at the end of September from 95.6% at the end of June, and asking rental rates have increased 5.5% since the acquisition in late April. These figures highlight the ongoing return to downtown living as the negative impact of the pandemic disease. It is a very similar story at The International in downtown Calgary. Occupancy was also 98% at the end of the third quarter and asking rental rates have increased 4.9% since the acquisition closed in early May. Turning to Slide 17, you'll find some highlights from our ESG report, which we released last month. Firstly, we reduced energy consumption by 11% and carbon emissions by 13% from the 2019 benchmark levels. Secondly, 50% of the individual annual bonus compensation is tied to performance against ESG adjusted. Thirdly, we began construction on 100 affordable suites of the rich growth property with support from the city of Toronto. And lastly, we completed our first inaugural Diversity and Inclusion survey. The full report is available on our website, and I encourage you to read it. We are proud of the progress we have made on ESG initiatives to date and are committed to achieving greater performance in the months and years ahead. I'll now turn it back over to Michael.

Thanks, Julie. I'll conclude with our business outlook on Slide 18 before we take your questions. We're pleased with the steady improvement in the REIT's financial performance over the course of 2022. We've capitalized on the strengthening industry fundamentals. They include the rising cost of homeownership, Canada's expansive immigration policy and inelastic housing supplies. It's just not keeping up with demand. The affordability gap between owning and renting a home increased substantially as housing prices remain high and mortgage rates have increased sharply. With regards to immigration, Canada has set an ambitious target to add 500,000 permanent residents per year by 2025. These people will need places to live and rental housing is necessary to meet that demand. Over the last year, we've seen downtown environments come alive again as students have returned to in-person learning and restaurant, sporting events and cultural attractions have drawn big crowds. Downtown living and renting is once again highly attractive. Finally, I want to note that strong commodity prices have solidified the rental market conditions in Alberta, which lagged our other markets over the last few years. Put together, we believe the outlook for the Canadian urban rental market will remain strong for the foreseeable future, especially if you consider that the multi-family sector has historically performed well during a recessionary period due to the short-term nature of our leases. To achieve long-term success, we remain focused on these 5 key strategies: growing NOI by maximizing revenue, optimizing occupancy, creating value from suite repositioning and minimizing operating expenses. Strategic allocation of capital, which may include capital recycling opportunities, accretive investments in deleveraging, best-in-class execution of our existing intensification development pipeline in order to further upgrade our portfolio, third-party acquisition or development opportunities, which will be market dependent, and finally, prudent balance sheet and liquidity management. Regardless of the short-term capital markets volatility, the key elements of our strategy have not changed. We're confident that by sticking to them, we will deliver strong returns to unitholders as the fundamentals of the apartment sector remains strong. That concludes our presentation this morning. Julie, John and I would now be pleased to answer any questions you may have. Pam?

[Operator Instructions] Your first question comes from Sairam Srinivas with Cormark Securities.

Julie, Jon and Michael, congrats on a great quarter. Just looking at the occupancy numbers. Obviously, this quarter saw a huge amount of occupancy gains coming in. I was wondering if you guys could kind of give us some color on the breakup of these occupancy gains across markets and there are some markets where you saw a better performance related to others?

It's Jon. Thanks for the question. Yes, the occupancy, we experienced a stronger occupancy, both in Toronto and Ottawa. Both of those are above 98%. Calgary is in more in the mid-90s, kind of 96% or so. And where we see the biggest opportunity for increasing our occupancy is actually in Montreal, where we're just a tick over 93%, which we're quite happy with because we've been kind of bouncing along between 89% and 91% since the onset of the pandemic. And so it's nice to see the hard work of our operations team starting to bear a little bit of fruit in Montreal with our occupancy kind of ticked up -- broke through 93% last quarter.

Just probably transitioning from there into the gain-on-lease potential. I think across every other market, we saw a huge gain, a material gain in that potential, except for Montreal, where I think that number has come down a bit quarter-on-quarter from Q2. Can you just speak about the fundamentals there and the opportunities you're seeing there from a rental perspective?

For Montreal, you're saying, Sai?

Yes, that's right.

Yes. Look, in Montreal, I think what we've experienced, and I think you saw this when you were on our property tour. The cost for us to turn the suites has been a little bit higher than other places, the time it's taken us to turn the suites is a little bit longer. So market rents are increasing in Montreal. I would say the pace at which is slightly less than others, but when there's double-digit potential for gain-to-lease in any market, I think that's quite attractive and Montreal is still there for us.

And finally, Michael, on the outlook, you mentioned capital recycling opportunities as one of the avenues for adding value. Just wondering if you guys have any targets on that sort of any opportunity you see on that side?

Well, I think you're talking about the Edmonton portfolio that we talked about. Is that where…

Yes.

So I mean, we're continuing to work that process. We have nothing that we can announce at this point, but we're optimistic that we'll be able to share some news shortly.

Your next question comes from Jonathan Kelcher with TD Securities.

Just continuing on the operation side. Your period-end occupancy was 97.4%. Is that holding through Q4 or do you think we'll see a seasonal dip?

I think as the market continues to tighten, we are starting to see a little bit more of a reversion back to what I'd call normal seasonality for this sector. October was relatively consistent with September, we went down about 1 basis point in terms of occupancy. The weather in October was pretty warm up until right now, actually, as we kind of look at our office. It's pretty beautiful outside. And so we're hopeful that the leasing season has extended a little bit. But look, there we are facing some headwinds overall in Q4. In terms of our utility costs, it's a tough comp in Q4 for us, right, because the rates for natural gas, in particular, in Q4 2021 were significantly lower because that was kind of pre-Ukraine war. So we're -- that's a tougher comp for us where the rates from trough to peak are kind of 2 to 3x. So even if our usage is the same, it's going to be pretty elevated. But in terms of occupancy, we're pretty happy with our performance in October.

And then on the Fifth and Bank loan that got extended, is that that's on -- assuming that's on the same terms as previous?

That's correct.

And then on capital recycling, you did take a small little fair value decline this quarter. Was that the Edmonton portfolio changed at all?

No, it didn't. So no change in Alberta, whatsoever. It was just a few properties in Ottawa and Toronto.

And then beyond the Edmonton portfolio, are there any other properties that you might be thinking of selling?

What I'd say is this is we take a very active portfolio management sort of stance. And so we're constantly evaluating our portfolio for opportunities. As well, when we think about our pipeline of deals that we have outside the REIT looking for opportunities to upgrade the portfolio. And so I would say there are no sacred cows. We would look at our entire portfolio from a forecast in terms of the performance of each asset and their fit with our strategy. And so I would say that we take a very expansive view, Jonathan, on sort of potential candidates for capital recycling, particularly if we think that we can make better use of the capital in other investments.

Just to layer on to that, if we can potentially reduce exposure to older rent controlled assets and take that money and invest it into new non-rent controlled assets. I mean, I think that would be for us a transaction that makes sense.

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

Just on the refi that you expect to do on Niagara West and The International. I know you're going to -- you're fixing the term. Are you going to pull out any incremental capital on that transaction?

No, we're not.

In Alberta, Jon, I think you highlighted the strong rent spreads across the portfolio, but good to see the new leasing spreads in Alberta be in that mid-teen range. Curious if you could give us some commentary in terms of what you guys are seeing on the renewal side since it's not subject to rent control?

Yes. I mean, look, it's broad strength across the portfolio. We're seeing particular strength in The International. I think as Julie highlighted, we've pretty much eliminated promo from most everything. I think there's a touch -- there's a little bit of competing products going around The Quarters and The Laurier. And so we're keeping a very close eye on that. But it's pretty consistent with the rest of our portfolio in terms of just broad market strength with rents up 5% since we acquired The International, in particular.

But I mean, just in terms of the renewals, like broadly speaking, for Alberta, would you guys be doing something above, say, the 1.2 or 1 point what you're getting in Ontario just due to the limit?

Yes. I mean, we're seeing just bringing everyone up to market rents with our promo.

And then last question for me before I turn it back. Just on the convertible development loan program, is the 5% discount and the value that you capture, is it a one way or if in the event that you pass on a project or gets recapitalized in another manner, do you still capture the 5% value creation on that?

So are you asking about the instance where the REIT would waive on its ROFO right?

Yes.

We haven't encountered that situation, but when the REIT has waived on deals, particularly in the last -- that instance has occurred in the last 12 months, let's say, when we've been more restricted in our ability to access the capital markets, MPI has pursued some deals with the concurrence and approval of the independent trustees on the REIT board. And what we've undertaken, I would say, is the best effort sort of approach, whereby when market conditions improve and our cost of capital returns to where we think it should be, that MPI will use its best efforts to bring those investment opportunities back to the REIT. Whether that would come in the form of a CDL investment, which is possible because some of those opportunities are in the predevelopment stage, and so there would be ample opportunity for the REIT to participate in the development, which is obviously first prize for the REIT because the CDL structure allows the REIT to garner the vast majority of the economics from development and is ring-fenced from most of the risk in terms of cost overrun schedules risk, lease-up risk, those risks all remain with MPI. So we're looking for opportunities to do that, Mike, if the capital market conditions improve and we see our cost of capital come back down to sort of where it should be.

I guess what I was asking more specifically was just in the event. I know you had an extension on Fifth and Bank until mid-2023. But in the event that the REIT wasn't able to exercise its discount purchase option once the property hit stabilization. That 5% value capture on purchase, is that something that the REIT is still entitled to if the property doesn't sell or recapitalize in a different manner?

No. I mean, the purchase discount is attached to -- it's part of the CDL instrument. So if the CDL was to mature and it was to be repaid that the option goes along with it, unfortunately.