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

Good morning. My name is Michelle, and I will be your conference coordinator today. At this time, I would like to welcome everyone to the Minto Apartment Real Estate Investment Trust 2022 Fourth Quarter Financial Results Conference Call. [Operator Instructions] Before we begin, I want 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 could 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 March 8, 2023, for more information. During the call, management will also reference certain non-GAAP financial measures. Although the REIT believes these measures provide useful supplemental information about its financial performance, they are not recognized measures and do not have standardized meanings under GAAP. Please see the REIT's MD&A for additional information regarding non-GAAP financial measures, including reconciliations to the nearest GAAP measures. Thank you. Mr. Waters, you may begin your conference.

Thank you, Michelle and good morning, everyone. I'm Michael Waters, Chief Executive Officer of Minto Apartment REIT. I'm joined on the call today by Jonathan Li, our President and Chief Operating Officer; and Edward Fu, our Chief Financial Officer. I'll begin the call by providing an overview of our fourth quarter and full year financial results and other corporate developments. Eddie will review our financial results in detail and Jon 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. For the full year, our operating performance improved significantly as Canadian urban rental market strengthened. We generated strong same-property NOI growth of 7.5%, reflecting solid growth in rental rates and increased occupancy. Average monthly rent increased by 4.6% to the same property portfolio and revenue grew 8.3%. Our AFFO increased by 12.3% compared to the prior year and AFFO per unit increased by 3.4%. Moving on to other highlights from the year. As you are likely aware, we increased our annual cash distribution by 3.2% to $0.49 per unit. We're proud that as a result of increasing our distribution in each of the 5 years since the REIT was created, we were added to the S&P/TSX Canadian Dividend Aristocrats Index in January 2023. We acquired 2 premium downtown properties, Niagara West in Toronto and the International in Calgary consistent with the REIT strategy to own high-quality assets in urban locations. And ESG continues to be an important strategic priority and we're very proud of the outstanding results outlined in our 2021 ESG report, which was published in October 2022. And we made significant advances on our senior leadership succession plan. In January, Jon Li was appointed to be our next CEO and will assume the role effective April 3. In addition, Eddie Fu was selected as the REIT's next CFO and took over the role from Julie Morin in January. These are critical steps and a recent internalization plan, as Jon and Eddie are both full-time employees of the REIT. The REIT now has a similar management structure to many of the grocery chain sponsors and retail sponsored REITs at the time their IPOs. Jon and Eddie have proven to be outstanding leaders and I'm confident that we have the right people in place to shepherd the REIT into its next stage of growth. I'll now review our fourth quarter operating performance on Slide 4. It was another strong quarter in what was typically a slower time of the year. Average monthly rent of the same-property portfolio increased 4.6% year-over-year and average occupancy increased by 210 basis points to 97.1%. Year-end occupancy was even higher, topping 97.6%. We achieved a gain-to-lease in the quarter of 16.6%, which was our highest quarterly gain-to-lease since the onset of the pandemic and the second highest in the REIT's history. We had strong double-digit rent growth in all of our markets and our annualized gain-to-lease potential increased to 13.6%. NOI for the same-property portfolio improved by 7.2% compared to Q4 last year, while same property NOI margin dropped by 30 basis points, reflecting cost pressure. Total portfolio annualized turnover was 21.5% for the quarter, reflecting a typical seasonal decline and strong market fundamentals. We believe turnover will continue to moderate due to a shortage of affordable housing alternative. Moving to Slide 5, where I want to cover a few other highlights. Firstly, we collaborated with 4 of the publicly traded apartment REITs to launch the website ForAffordable.ca in November. We thought it was important to dispel myth about how we operate and spread facts and policy ideas about how we can help address the housing supply and affordability prices in Canada. Though NOI growth was strong in the fourth quarter, FFO and AFFO per unit declined primarily as a result of increased floating interest rate. Finally, just 2 days ago on March 7, we completed the sale of Hi-Level Place, one of our 3 properties in Edmonton. The sale was completed as part of our capital recycling strategy and the sale price was approximately $10 million, in line with our Q4 2022 fair value for the asset. I'd now like to invite Eddie Fu to discuss our fourth quarter financial and operating performance in greater detail.

I am pleased to have the opportunity to speak with all of you on earnings calls for the first time. Turning to Slide 6. In-property portfolio revenue increased by 7.6% year-over-year, reflecting higher occupancy, higher average rents and reduced amortization of promotions. In-property portfolio NOI grew by 7.2% from Q4 last year, a margin of 61.2%. FFO per unit in Q4 2022 was $0.196, a reduction of 8.7% and AFFO per unit declined 10.1% to $0.17 per unit, reflecting higher finance costs, spurred by the impact of rising interest rates on variable rate mortgages and increased draws at interest rates on the REIT's credit facility, partially offset by higher NOI. Average monthly rent in Q4 2022 was $1,738 for the same-property portfolio, representing an increase of 4.6%. Average occupancy was 97.1% for the total portfolio, up 210 basis points from 95% in Q4 last year. I will now turn it over to Jon Li to review our operating performance and growth initiatives. Jon?

Thank you, Eddie. Moving to Slide 7. The upper chart shows that gain-to-lease and average monthly rent trended very positively over the last several quarters as the Canadian urban rental market has steadily recovered from the negative impact of the pandemic. The lower chart, we break out rents by geography. In addition, our rental product continues to be an affordable alternative to homeownership. Moving to Slide 8. As Michael noted, we generated double-digit gain-to-lease in all of our markets. The average rent on new leases increased 16.6% to $1,981 per suite. That was the second largest quarterly gain in the REIT's history. Furthermore, as a result of increasing rents, the embedded gain-to-lease potential of our portfolio increased to 13.6%. On Slide 9. Strong rental demand is driving higher occupancy for the REIT. Contrary to seasonal trends, move-ins have exceeded move-outs in 6 of the last 7 quarters. On Slide 10. Average monthly rent for the furnished suites has improved materially, with only a slight decline in occupancy relative to last year as travel has returned to normal levels, particularly in the film industry and business executive stays. Slide 11, property operating costs in the fourth quarter increased due in part to higher labor costs, filling staffing vacancies and higher repair and maintenance costs. Higher natural gas costs were a key contributor to increased operating expenses as rates increased 47% year-over-year, with consumption in line with the prior year. So far in 2023, gas prices have dropped significantly. We are working hard to minimize operating costs and we are pleased to see that inflationary pressures showed signs of slowing by the end of the year. Slide 12. We renovated and leased a total of 41 suites in the fourth quarter, which generated an ROI of 11.3% on our proportionate share. We repositioned 259 suites in 2022 and expect to reposition between 80 and 120 suites in 2023, reflecting lower anticipated turnover. Slide 13. In 2022, we made initial advances on the University Heights convertible development loan to Minto property in supporting an exciting development of a large mixed-use residential properties in the Greater Victoria area. Overall, we have 8 projects in our pipeline, 5 of which are under construction and one of which is stabilized. 5 of our investments consist of convertible development loans with exclusive purchase options upon stabilization and 3 are direct investments in properties we own. These projects have the potential to increase the REIT's gross suite count by 2,302 suites by 2029. On Slide 14, we will provide a status update on 2 of our developments. Beginning with Fifth and Bank in Ottawa, it is highly unlikely the re-exercises its purchase option in the near future and therefore, MPI and the REIT are currently in discussions to extend it. Lonsdale Square has the potential to be the REIT's first foray into the strong Greater Vancouver market. It was topped off in December and stabilization is expected to occur in the first quarter of 2024. Now I'll turn it back over to Eddie to review our debt financing and liquidity.

Thanks, Jon. Turning to Slide 16. Core elements to our strategy is to maintain a conservative leverage ratio and a balanced debt maturity schedule. As the chart shows our debt maturities are nicely staggered through 2027 and the debt coming due this year provides opportunities to maintain a balanced maturity schedule. As discussed earlier in the call, our FFO and AFFO in the fourth quarter were impacted by higher interest rates on our variable REIT debt. At the end of 2022, we were carrying $265.5 million of variable REIT debt with a weighted average interest rate of 6.87%. We expect to refinance $108.4 million of variable rate mortgages with fixed rate CMHC insured mortgages for Niagara West and the International in early Q2. Closing these loans, our proportion of fixed rate debt would increase to 86% with the CMHC portion rising to 73%. In addition, we plan to further mitigate our exposure to variable rate debt through proceeds from upward debt refinancing and other deleveraging strategies. Finally, I want to note that total liquidity was approximately $115 million at the end of December 2022 and debt to gross book value was 40.6%. I'll now turn it over to Michael.

Thanks, Eddie. I'll conclude with our business outlook on Slide 17 before we take your questions. Our performance in 2022 reflected a strong recovery in Canadian urban rental market conditions following the negative impact of COVID-19. Looking ahead, we believe that we're positioned to further strong performance as the fundamentals underpinning this sector remain very robust. This includes a further deterioration in housing affordability due to rising interest rates, continued growth in integration and inelastic housing supply. It's not surprising that the increasing proportion of Canadians are opting to rent a home to the only one in this environment. To achieve long-term success, we remain focused on 5 key strategies: growing NOI; the strategic allocation of capital, which may include reducing variable-rate debt and/or buying back units; generating capital through internal sources to fund our growth pipeline; the execution of our intensification development pipeline; and prudent balance sheet and liquidity management. We believe that executing on our strategy will position us for solid growth in FFO and AFFO per unit. This is the last time I'll be speaking with you all on an earnings call. It's been a pleasure and a privilege to serve as the CEO of Minto Apartment REIT since its formation and IPO. I'm very confident that through our succession planning, we have the right team in place to lead the REIT to further success to drive strong returns for unitholders. That concludes our presentation this morning. Jon, Eddie and I would now be pleased to answer your questions.

[Operator Instructions] Your first question will come from Sairam Srinivas of Cormark Securities.

Michael, it's been a pleasure working with you and all the very best for the next steps ahead for you. And Jon, Eddie, looking forward to working with you guys as well. First off, gents, thank you for the additional disclosure in the quarter. This was really helpful. My first question is primarily on organic growth. How do you see the lookout for 2023? And how should we be thinking about the broader SPNOI growth in this year?

Yes. So it's Jon. Thanks for the time. You're asking sort of overall growth for 2023. Is that what I heard?

Yes, that's right.

So just at a high level, I think our revenue growth we expect to be consistent with what it has been recently. So we are hopeful we can get high single-digit growth in revenue. We suspect revenue growth will outpace our expense growth, not by a ton, but a little bit and we're optimistic that we'll get a little bit of NOI margin improvement over the course of the year.

So Jon, would you say that maybe in line with high single digits or high single-digit NOI as well?

Correct.

Okay. That makes sense. And probably my next question is kind of tied to a couple of aspects and that's essentially around recycling. And Eddie, to your point about reducing the variable rate exposure for the REIT. So how do you guys plan on actually executing that? And could you comment on the recycling aspect of the program as well?

Yes. So we are considering -- we're evaluating lots of other transactions that we can generate equity capital internally. I think the high probability of that will likely be further asset sales. And we'll recycle the proceeds of those asset sales into either higher growth assets or paying down our variable rate debt or buying back units. And today, with the high cost of our variable rate debt, I think it makes a lot of sense for us to pay back that debt is quite financially attractive. We're not going to provide guidance on which assets we're going to look to sell, nor their locations because we think that will best position us to maximize proceeds and maximize auction tension and keep it confidential and we don't want to put an expectation out there in the market. And just right now, look, the execution risk of selling these assets in this market is high. It's not an easy slam dunk to sell some of the assets we're looking to sell. We're cognizant of that. And so we're going to look for attractive deals on a bunch of different assets and we'll see when we go back with them. We'll update the market once we have something to update the market on.

And that's fair, Jon. Eddie, on the refinancing bit, once the CMS refinancing is done, where do you see those rates coming in that?

You're asking what do we see in terms of the rates?

Yes. So the -- sorry, go on.

So with our CMHC is priced off of our CMPM looking at, let's say, at a 10-year term. Currently, the pricing would be around 4.25% to 4.5%.

All right. Actually that's -- that's actually a good -- all right. And I think my last question, gents, in terms of turnover, I know it's been a bit of a slowdown in the last couple of years now. How do you see portfolio turnover trending in '23?

Yes. So we ended the quarter in the low 20%, I think 21.5%. Let's not forget that Q4 is a typically lower turnover quarter. What we're seeing in January and February and March to date, I'd say, again, Q1 is also a slower turnover quarter is moderating even lower than that 21.5%. So that's what we're seeing. It's really not surprising. It's very -- it's different in different markets. Obviously, Calgary is slightly higher and some of our affordable properties in Toronto are much, much lower. The good news is we have between 15% and 20% of our portfolio is not subject to rent control. So that helps. And -- but let's face it. I mean we think turnover is moderating.

Your next question comes from Jonathan Kelcher at TD Cowen.

Just to clarify first on the potential asset sales, you would -- I'd assume you're also looking -- you'd be looking at partial sales like selling an interest in properties?

Yes. Look, I think it probably wouldn't surprise you that a lot of the assets we're trying to sell are likely our older assets, a combination of high rise and low rise. Finding the institutional partners for those, we could. But I think Plan A would be for us to sell those outright. I think if we were looking to partner on potentially some newer assets that were higher growth, I think partnering with some JV partners would be easier to execute on those. But I think that's also Plan B. So for us, Plan A would be likely to sell our older assets that are under rent control in certain markets and maybe even some of our low rise and that would be Plan A.

Okay. Fair enough. And then just on the slowdown in expected suite repositionings, is that fully a function of lower turnover? Or is some part of that just that the market is strong enough that you can still get a very good rent uplift without going through the repositioning expense?

Yes. It's a good question, Jonathan. And I think the way we're thinking about it is a lot of it is driven by both the reduced turnover that we're expecting as well as the overall lower -- or lower vacancy in our portfolio. So this is a less whitespace for us to do these renovations. That's number one and 2. And then number 3, the opportunity cost of taking a unit offline for 3 to 4 months has increased substantially with rental rates increasing and the market demand that we're seeing. So our asset management team reviews every single unit that's coming back to us a couple of months before once we get the notice. And we're running the math on, all right, well, what does it look like if we simply put a new tenancy in that market with a standard turn it takes 3 days for new paint and et cetera, versus taking it offline for 3 to 4 months, putting $50,000 into it and losing that opportunity cost of 3 months of market rent. So we're doing that analysis on a suite-by-suite basis and are making a determination based on return based on that math. And so it's kind of a combination of all 3 of those things that you just said, which is driving us down to 80 to 120. And to put it into context, it's not a lot of dollars, right? Like our repositioning program as a whole is less than $10 million for 2023.

Okay. That's helpful. And then lastly, just on the financing, the $108 million on International and Niagara Street. Since you bought those, I'm guessing the NOIs improved nicely. Do you think you can get more on the fixed rate debt when you go and do that, some up-financing there?

Yes. So on Niagara, the reality is we -- part of what explains the delay is that we had to have 12 months of stabilized performance for CMHC to look at. And that clock didn't start until November 2021. So we didn't submit until November 2022. And by that time, yes, a lot of the rental rate improvement that we experienced was part of our submission. And on the International, we actually purposefully resubmitted in December of last year because of that exact reason. So the loan amount that we got or that we submitted in December was $15 million higher than what we originally underwrote back when we purchased these assets.

Okay. So just to be clear, so how much fixed rate debt are you expecting to get at the end of March, beginning of April?

$108 million.

Your next question comes from Brad Sturges at Raymond James.

Just on the capital recycling. Obviously, you're not giving guidance on assets specifically, but just curious if you have a quantum or a dollar amount you think could be achievable in terms of asset sales this year as you think about what's under review right now?

Yes, I don't think we're going to be giving you a target, Brad, unfortunately, because we have a number of assets that we've identified. There are assets that we think are higher probability execution than others and it's just too big of a range. And so I think you can kind of look at what our capital needs are over the course of the next 2 years, you can think about what's in the pipeline, you can look at how much variable rate debt we have left to pay down. And as you can triangulate in terms of what our target will be from there.

Okay. But you would expect, I guess, at the very least, the Edmonton assets remaining would go back on the market for sale at some point in the spring or summer, perhaps?

Yes, I think that's right. And I guess we haven't addressed it specifically on this call. So we did sell Hi-Level for $10 million. We are happy with that sale price. There are 2 remaining assets. We are going to put the other 2 -- we're going to take them off the market, but we are going to relaunch them at some point. There is interest in the properties. They're attractive buildings. But what we're observing is our negotiating leverage just is not optimal today as buyer pools remain relatively thin and to be quite honest, we're just not happy with the pricing that we have today. And the Edmonton market continues to improve week-by-week. Vacancy is getting better, or smaller promotion uses is now 0 and it still remains a relatively affordable market compared to other markets. So for us, there's no reason to sell at suboptimal pricing or what we think is suboptimal pricing today and we're in no rush to sell. So we'll relaunch it when we think there's more auction tension in the market and buyers will be more aggressive than what we're seeing today.

Okay. Just on Fifth and Bank. Obviously, you discussed there's the potential for an extension there on the purchase option. What would that look like? Would that be another 6-month extension to the end of the year? Or would there be a different framework in mind?

Maybe I'll tackle that one. I think what we're looking at is probably a further extension perhaps as late as the end of the year. I think that MPI -- speaking [indiscernible] wants to support the [ rebus ] to be constructive for the REIT. And given the unit price and capital availability, I think that we'd like to give it another 6 months. So that's a proposal that Jon and I are working on right now to take it to MPI and get approval to, but to extend it further. So -- and that's a process that's been very collaborative. They say MPI wants to be constructive and support the REIT, we'll undertake that process and hopefully have some more information on that for the market in the very near future.

And I would also add that from the REIT's perspective, we're going to remain disciplined. We're not going to buy it anytime soon because the cost of debt would be higher than the cap rate. And I think for us, that doesn't really work. MPI can't hold it forever to be quite honest and Michael doesn't want to say this, but they could sell it immediately for a higher price than they can sell it to the REIT to tomorrow. So we very much appreciate that they're working with us and we hope to, but we're going to remain disciplined and that's -- we're kicking the can down the road. Yes.

So for the option to make more sense of the REIT, effectively, it sounds like you'd have to have a good line of sight on capital recycling to the point where you can pay down debt, but also it makes more sense to exercise that option?

Yes. I mean I wouldn't disagree with anything you said. It's not the only thing we're looking at, but that is a frame -- is consistent with the framework that -- what they do.