Canadian Apt Pptys' CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Canadian Apt (CDPYF)

Canadian Apt Pptys (OTC:CDPYF) Q1 2013 Earnings Call May 8, 2013 12:00 PM ET

Executives

David Williams – Corporate Director

Thomas Schwartz – President and Chief Executive Officer

Scott Cryer – Chief Financial Officer

Analysts

Frederic Blondeau – Dundee Capital Markets

Mario Saric – Scotiabank

Heather Kirk – BMO Capital Markets

Matt Kornack – National Bank Financial

Jimmy Khing Shan – GMP Securities

Michael Smith – Macquarie Securities

Operator

Good morning, ladies and gentlemen. Welcome to the Canadian Apartment Properties Real Estate Investment Trust First Quarter 2013 Conference Call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. David Mills. Please go ahead, Mr. Mills. David Mills

David Mills

Thank you, Melanie. Before we begin, let me remind everyone that the following discussion may include comments that constitute forward-looking statements about expected future events, and the financial and operating results of CAPREIT. Our actual results may differ materially from these forward-looking statements, as such statements are subject to certain risks and uncertainties, discussions concerning these risk factors, the forward-looking statements, and the factors and assumptions on which they are based can be found in CAPREIT's regulatory filings, including our annual information form and MD&A, which can be obtained at SEDAR.

I'll now turn things over to Mr. Tom Schwartz, President and CEO.

Thomas Schwartz

Thanks, David, and good morning everyone. As you know 2012 was the most active year in CAPREIT’s history as we generated record growth and record results. On the growth front shown on slide 3, we acquired 6,984 suites and sites during the year, for a total acquisition cost of CAD$719.3 million, financing these purchases were two successful bought deal equity offerings, raising net proceeds of CAD$345.3 million, the portfolio growth in 2012 significantly enhanced the diversification of our portfolio, both geographically and by property type, and with the purchase of the Killam portfolio in May, we strengthened our presence in the very strong manufactured housing community business.

Most importantly, these new properties are now making a solid and accretive contribution to our NFFO, as you can see in our first quarter results. As we apply our proven property management programs, we are confident cash flows will only get better. With our record portfolio growth and the continuing success of our property management programs, we also generated record results in 2012, as you can see on slide 4.

Revenues were up 13.9% on the partial year contribution from our acquisitions, as well as continuing strong occupancy and increased average rents in our residential suite portfolio. As a result, NOI increased 15.4% with our NOI margin rising to 57.7% from 57% in 2011. Normalized funds from operations, the key measure of our performance rose almost 28% in 2012. Importantly, this growth was highly accretive as NFFO per unit was up a solid 9.5% and even with the 3.7% increase in monthly cash distributions implemented in August, and then approximate 17% increase in the weighted average number of units outstanding, our NFFO pay-out ratio improved significantly to 76.4% in 2012 from 82.8% in 2011.

Slide 5 clearly shows that this growth in progress is continuing in 2013. Operating revenues were up 21.1% in the first quarter, primarily due to the contribution from acquisitions completed in 2012. NOI increased as a result of the solid revenue growth, as well as the strong 3.8% increase in same property NOI, resulting from our proven operating programs.

Our NOI margin remained very strong at 55.1% down slightly from 55.4% last year, due primarily to higher utility costs this year. You can also see that despite an approximate 20% increase in the weighted average number of units outstanding, our growth was highly accretive with NFFO per unit up a strong 8.7% and our NFFO pay-out ratio also improving to 79.3% from 83.5% in last year’s first quarter.

As a result of our growth and performance we are very pleased to have increased our monthly cash distributions by 3.7% in August last year equating to an annualized distribution of $1.12 per trust unit, the ninth increase in our 15-year history as a public company. Looking ahead the future looks very bright for CAPREIT, and we look forward, confident in our ability to continue enhancing unitholder value in the years to come.

I’ll now turn things over to our CFO Scott Cryer to review our record results in more detail.

Scott Cryer

Thanks, Tom. Side 8 details how we performed by asset type, with average monthly rents increasing across all segments of our residential suite portfolio, resulting an overall 2% increase. Also, as you know, rent guidelines in Ontario and BC are lower this year than last.

Occupancies were impacted marginally by acquisitions completed in 2012, with higher vacancies, but we fully expect to see these improve in the quarters ahead, and should provide opportunity for future growth. The change in land lease portfolio is due primarily to the lower rents charged at the Killam portfolio, acquired in May of last year.

Looking ahead, demand remains strong in most of our markets, and we see occupancies remaining stable at these nearly full levels, and we believe the average monthly rents will continue to increase over time. As detailed on slide 9, solid AMR increases of 1% on suite turnovers and 2.8% on lease renewals were achieved in the quarter. The lower increase in AMR for suite turnovers is primarily related to the BC region and sub-metering in Ontario. As I mentioned, the lower rent guidelines this year of 2.5% in Ontario down from 3.1% last year, and 3.8% in BC down from 4.3% in 2012, impacted renewals in the quarter.

We are also continuing to seek above guideline increases at a number of properties, where we've invested in capital improvements. Slide 10 shows the performance of the stabilized portfolio for the first quarter of 2013. As you can see, increases in operating revenues, combined with a smaller increase in our operating costs resulted in same property NOI, up a strong 3.8% in the quarter. Looking ahead, we are confident the strong organic growth will continue. Market fundamentals are sound across the country, rent guidelines will continue to positively impact rent renewals, and our innovative energy and cost control programs are generating significant benefits. We will continue to enhance our operating platform through investments in IT, and our people.

We continue to maintain and improve our strong and flexible financial position, as shown on slide 11. Coverage ratios remain very strong with interest coverage continuing to exceed 2 times, and the improved debt service ratio is well within our guidelines. Our weighted interest rate declined further at quarter-end, and we have continued to focus on extending our debt maturities, with the use of 10 year, term mortgage debt. While more recently, attempting to balance our maturity profile with the use of shorter and longer duration mortgages.

Total mortgage refinancings of CAD$263 million were closed during the quarter, including CAD$152.6 million for renewals of existing mortgages, and CAD$110.4 million for additional top-up financing. The average term to maturity for these financings was 10 years, with a weighted average interest rate of 2.94%, considerably lower than the maturing rates.

We expect to raise between CAD$575 million and CAD$625 million in total to mortgage renewals and refinancing this year. Our liquidity position, as detailed on slide 12, continues to remain strong, despite the record and rapid growth experienced in 2012. Strong top-up potential on our mortgage portfolio will easily allow us to fund our CapEx programs, and should create incremental acquisition capacity throughout the year.

As at March 31, our liquidity position of approximately CAD$156.4 million could provide for future acquisitions of approximately CAD$520 million, while still maintaining a conservative debt ratio. Our mortgage maturity profile remained well balanced at quarter end, as shown on slide 13, and we continue to focus on extending our debt maturities in this low rate environment, but we will use various duration mortgages to achieve this.

With significant maturities and top-up potential of the next three years, we should have the opportunity to take advantage of the continued low interest rate environment. However, if rates begin to rise more rapidly, we may use this opportunity to balance our maturity profile for the years 2016 through 2020, with shorter duration mortgages.

With over 93% of our mortgages being CMAC insured, we continue to have a large and diverse group of lenders willing to work with us. As we continue to convert assumed mortgages in the number of properties we acquired in 2012 to CMAC insured mortgages, we see this percentage climbing. Currently the 10 year estimated market interest rate is approximately 2.75% and five year estimated current market interest rate is under 2.25%.

I’ll now turn things back to Tom to wrap up.

Thomas Schwartz

Thanks, Scott, following our record results in 2012, we see 2013 as another strong year for CAPREIT. First, we will see a full year's contribution from the record acquisitions completed in 2012. The positive impact has already been seen in our first-quarter results. Property revenues will also continue to benefit from our near full occupancy levels, and consistent increases in our average monthly rents. Our ancillary revenues continue to grow as we introduce new and innovative programs at our new properties. Our NOI margins will remain strong, particularly as we realize the benefits of our state-of-the-art purchasing and energy management programs at the properties acquired during 2012.

We also believe our portfolio will continue to grow. So far this year we have completed the purchase of a 263-suite apartment property in Calgary. After the first quarter, we committed under two separate agreements to acquire a portfolio of 514 units in Toronto and Calgary for around $82 million.

We expect we will achieve our normal target of acquiring between 1,500 and 2000-suites for the full-year of 2013. Longer-term, the future is very bright for CAPREIT. We have proven our ability to capitalize on continuing strong fundamentals in the Canadian Apartment business through all economic cycles. We believe, we have one of the strongest balance sheets in the business, and fiscal prudence will remain a key priority of CAPREIT. We are very confident in our team, and we have the right people in the right positions to manage our growth for years to come. And finally, we have demonstrated that our business strategy is working, and we will continue to build on solid performance generated over the last 15 years. The main message today is that CAPREIT has a very exciting future, and we look forward to sharing our results with you in the coming quarters. Thanks, for your continued interest, and I want to invite everyone to attend our Annual Meeting, being held at 4:30 in the afternoon on Tuesday, May 21, at 1 King West in downtown Toronto.

Thank you again, and Scott and I will now be pleased to answer any questions you may have.

Questions-and-Answers Session

Operator

Thank you. (Operator Instructions) First question is from Frederic Blondeau of Dundee Capital Markets. Please go ahead.

Frederic Blondeau – Dundee Capital Markets

Hi, thank you. Just a quick question here. In terms of subsequent events, what kind of a cap rate environment do you see out there in terms of acquisitions regarding that CAD$82 million acquisition you just did?

Thomas Schwartz

Frederic. We're tied to a confidentiality agreement on that particular property, so I can’t talk about cap rates, but what I will talk about is general, cap rates are sub 5% now in virtually all markets in Canada. Montreal is the only market they are still hovering around 5%. So I think you have to assume that cap rates have 4% in front of them now. What we look for and for something today is quite accretive, because as you can see, we're financing at significantly under 3%, but again, we look for the upside and the value we can add in all of these acquisitions, and that's the most important part to us. They are also strategic, they are in locations where we have existing management capacity, and again, strong existing portfolios.

Frederic Blondeau – Dundee Capital Markets

All right, thank you very much.

Operator

Thank you. The following question is from Mario Saric of Scotiabank. Please go ahead.

Mario Saric – Scotiabank

Hi, good afternoon.

Thomas Schwartz

Hi Mario.

Mario Saric – Scotiabank

Just a really quick question on the balance sheet, I think Scott, you mentioned you have acquisition capacity of CAD$520 million or so. Is that presumably to get to a debt to gross book value of 55%?

Scott Cryer

I mean, really the math there is just leveraging our liquidity at a 70% on acquisition, that's really where you get to the gross asset amount.

Mario Saric – Scotiabank

Okay. I'm just wondering, how comfortable do you feel kind of inching up on the debt to GBVs at this stage, is there 100, 200, 300 basis points of upside in your view, given the availability of debt, and given where fundamentals reside today? And how does that view change if we see kind of continued cap rate?

Thomas Schwartz

I mean, in my view Mario, is we’re significantly underlevered considering the stability of the apartment. On the other hand, it's certainly helping our cost of capital. As you see, we're still able to grow NFFO and AFFO with these very low debt ratios, so we have no intention of running it up to anything obscene. But as you said, we've got tremendous acquisition capacity and we'll use it, but we'll also take advantage of the fact that our cost of equity is low as well today.

Scott Cryer

Yeah, I think liquidity is definitely the key area of focus for me. I'm comfortable with our debt levels increasing, but as long as we're in a liquid market, if things change over the next couple of years, so that's really the focus for me.

Thomas Schwartz

When you talk about accretiveness, you’ve to look at these low numbers. I mean, buying a 4.5% cap and financing at 2.7% is way more accretive than buying an 8% cap and financing at 5.5%, which we thought was pretty good a few years ago.

Mario Saric – Scotiabank

Yeah, now understood. Okay, my second question, just with respect to I think Scott, you touched on it a little bit, with respect to the gap in rent growth between suite turnovers of 1% and renewals of 2.8%, did you mention the gap was driven by the sub-metering as well as BC? Can you give me a sense of kind of how much of each of those played into that gap?

Scott Cryer

Yeah, so I would say close to 50% of the turnover in the portfolio was in Ontario and of that, there was a probably about 50% which was sub-metered during the quarter, so that really has an impact on our overall increases. I think the second component is BC. We've had two years of very strong renewal guideline increases of 3.8% and 4.3%. So there has been some evidence that it's a little harder to move rents on turnover because of that strong growth that we've had over the last two years, but BC continues to be one of our strongest margin regions, so we're still very happy with the performance overall. And I think, finally, Quebec is playing into that. It's a little bit of a slow season right now, and so Quebec is unique, in that there is a greater percentage that happens in the July period. So we’ll look forward to the renting in Q2 and how that looks.

Mario Saric – Scotiabank

And on the sub-metering, is it fair to say given that's still a positive 1%, is it fair to say you're still able to hold rent for the most part?

Scott Cryer

Yeah, that's what we're seeing in Ontario it’s above flat, but I think we've told the story, that even if it's a zero percent increase on sub-metering, you're doing very well, given the cost can be up to $50 per month. So…

Thomas Schwartz

Sub-metering is actually our most profitable initiative now the real question is how fast it rolls out.

Mario Saric – Scotiabank

Right, and I guess, on that front are you feeling as confident as you were, let's say last quarter or two quarters ago, about kind of flicking that switch on available suites as they turnover?

Thomas Schwartz

Yes, the answer is yes to that.

Mario Saric – Scotiabank

That’s great. Okay, thank you.

Operator

Thank you. The following question is from Heather Kirk of BMO Capital Markets. Please go ahead.

Heather Kirk – BMO Capital Markets

Just a follow-up on Mario's questions about the turnover lift. Is it fair to say, then, that although you're getting maybe less rental uptick, you're maybe getting it back elsewhere in terms of the up costs? Is that what I'm understanding on the sub-metering?

Thomas Schwartz

Yes.

Heather Kirk – BMO Capital Markets

Okay. And you mentioned Quebec. I'm just wondering, there's been a lot of press with respect to the condo situation in Montreal and some of that coming back on to the market, and I'm wondering if you're seeing signs of that affecting demand?

Thomas Schwartz

It is Heather, that’s actually the only market in Canada where we’re actually seeing that, but in spite of that I think you’ll see as Scott said earlier in July when the people coming to the rental market our buildings will tighten up quite a bit.

Heather Kirk – BMO Capital Markets

Okay.

Thomas Schwartz

WE also have a lot of capital work going on in Quebec and that affects occupancy as well and the capital work as it slows down we Belle-Rive is the prime example we're seeing now, tremendous occupancy increases at Belle-Rive, because we finished our capital program there.

Heather Kirk – BMO Capital Markets

So are the rents then between the condo stock and the purpose-built rentals narrowing as a result of this supply coming on?

Thomas Schwartz

Yeah, Montreal is the only market where the purpose built, where the condos are actually coming in at rental prices, where they can compete with the existing rentals.

Heather Kirk – BMO Capital Markets

I would imagine that Quebec City then is not affected by any supply issues?

Thomas Schwartz

Not to the same extent, no.

Heather Kirk – BMO Capital Markets

Okay and just lastly on the incentives…

Thomas Schwartz

That’s real phenomenon.

Heather Kirk – BMO Capital Markets

Okay, the incentives also picked up this quarter year-over-year, and I was just wondering if you could explain what markets you're having to use incentives in more, and what kind of incentives you're giving?

Scott Cryer

Yeah I think one of that one big factor was actually commercial lease that really was, I think, almost a third of that tenant inducement during the quarter, so some of it is actually on the commercial side, but we’re using them Halifax, Quebec and London, especially how those areas have new acquisitions, where we have lower occupancy buildings, and you can see that in our AMR schedules and our occupancy schedule, so incentives are beginning, as we generally try and increase occupancy before rent in those areas, so we are using incentives on those acquired properties to really get that occupancy up right out of the gate

Heather Kirk – BMO Capital Markets

So it's mostly the newly-acquired properties that would be having the incentives?

Scott Cryer

Yeah, I would say that is the majority of it.

Heather Kirk – BMO Capital Markets

Thanks very much.

Scott Cryer

Okay.

Operator

Thank you the following question is from Matt Kornack of National Bank. Please go ahead.

Matt Kornack – National Bank Financial

Hi guys.

Thomas Schwartz

Hi.

Matt Kornack – National Bank Financial

Just a quick question, in terms of the turnover on the aggregate, it looks like its come down from sort of mid 30s to sort of high 20s on a percentage basis. Is that because of the types of properties you're acquiring or is that because of how you're managing these buildings and you're keeping more of the tenants in?

Scott Cryer

I think turnover one impact that has had some impact was with the acquisition of the MHC portfolio, some of the turnover is lower in our MHC portfolio.

Matt Kornack – National Bank Financial

Okay.

Scott Cryer

I mean Q1 itself is not a high turnover period. You can see it's only 5.4%, which was fairly consistent with the prior year so…

Matt Kornack - National Bank Financial

Okay. And then in terms of the types of properties that you're buying, is it all types that you're looking at, or is there one asset, sort of affordable versus mid tier versus luxury that you think is best suited to this market environment?

Thomas Schwartz

We look at all acquisition opportunities, so it has to meet our geographic and our demographic criteria, but there's nothing that we don't look at. And then sometimes the affordable deal will work very well, sometimes the luxury of deal will work very well. I would say in general, what we've bought this year, and what we are looking at this year, is mid tier and above.

Matt Kornack - National Bank Financial

Okay, that's helpful. Thanks, guys.

Scott Cryer

Thanks.

Operator

Thank you. The following question is from Jimmy Shan of GMP Securities. Please go ahead.

Jimmy Khing Shan – GMP Securities

Thanks, just on the sub-metering, I wanted to get a rough sense of how impact full it’s been so far. So just rough numbers, what percentage of the portfolio would you say is now sub-meter?

Scott Cryer

So, it's about, I think we disclosed, it's about 30% of the 15,000 suites, that were sub-metered. A majority of those are really in Ontario so you can do the math from there. Some markets are actually, like Alberta was highly sub-metered before, so we're really discussing of the 15,000 that’s kind of net new over the last year and a half. And yeah, we moved at almost 4% from Q4 to Q1. So we are getting good traction. We're still trying to understand the experience as far as which units turnover and how quick we can move that turnover closer to the 70%, 80%. Because some of the units that turn are the same ones year-over-year, so I think it's hard to get a really good feeling for experience, but its been a positive NOI result, and we continue to make good headway...

Jimmy Khing Shan – GMP Securities

Right, so on the properties that have gone through the program, is it easy, like can you figure out like what kind of margin pick up you're getting on those properties on a before and after basis?

Scott Cryer

Yeah, I mean, I think the example that we’ve given that we’ve seen so far is if we have a CAD$1,000 monthly rent and we’re pass and we’re keeping the rent flat as a CAD$1,000 but we’re passing on CAD$50 of utility, of electricity, that's the equivalent of a 5% increase, so we, that’s kind of in the sense we’ve been getting so far, but, we continue to see more, as we see more turnover, we’ll get a better sense of that.

Jimmy Khing Shan – GMP Securities

Okay. And then Tom, you talked earlier about the cap rate spread through the borrowing costs, which is incredibly low. I was just curious at what point do you stop buying here? In other words, regardless of how cheap the borrowing costs, you say, I’m not going to go by below X percent, because the risk is too high.

Thomas Schwartz

I look at a couple of things Jimmy, first of all, besides the cap rate, we always look at the price per unit and you’ve heard me say over the years one of the great things about our business we buy assets to less than 50% of replacement cost. As these cap rates go down a lot of these buildings get closer to replacement cost and we’re not a player in that. Others are buying them and that's their business, but so that's major constraint for us. The other thing is, as always, we're not getting most of what we're bidding on today. There are people paying a lot more money than we are, so that's why I'm not as optimistic about our numbers, so that's kind of the situation. The other thing that's more interesting is a lot of our competitors are using shorter-term financing to justify. We're seeing, there was recently a deal this week, there's a deal in the Yonge-Eglinton area at about a 3.7 cap, we didn’t even bid on it.

Jimmy Khing Shan – GMP Securities

Right, but if you had something for 3.7 cap, but still well below replacement cost with good prospect, that's something that you would probably entertain doing?

Thomas Schwartz

But a 3.7% it’s getting very close to replacement cost.

Jimmy Khing Shan – GMP Securities

Replacement cost, okay.

Thomas Schwartz

That's the problem

Jimmy Khing Shan – GMP Securities

Yeah, okay.

Thomas Schwartz

Okay, thanks Jim.

Jimmy Khing Shan – GMP Securities

Thanks.

Operator

Thank you. (Operator Instructions). The following question is from Michael Smith of Macquarie. Please go ahead.

Michael Smith – Macquarie Securities

Thank you. Two questions. Just on your, Tom over the past years, you've been working very hard at increasing your geographic diversity. So my first question is, where do you think that might go over the next two or three years, and where ideally would you like it to go? And the second question is, what are your thoughts on building in markets like Saskatchewan and Atlantic Canada, where land is cheap, and you have only a small portion of your portfolio there?

Thomas Schwartz

So, let me answer the first question first. We've been working hard on the geographic diversity, fortunately this year and last year, we made good inroads, and in the West we continue. My perfect portfolio would 50% Ontario, 25% East of Ontario and 25% West of Ontario. And we’re kind of moving in that direction. I mean we've made very good end roads in Calgary this year, last year and the year before we did okay in BC.

So we are getting there. Montreal and Quebec City we’ve got great portfolios and we did make one significant acquisition in Halifax last year, so we're kind of getting the geographic diversity. In terms of the new construction, we're running the numbers, we are looking very closely, we are looking at our land inventory and we are looking at how we would approach that market, certainly with today's interest rates and with the slowdown in some markets of the condo market, that's going to make rental construction much more viable, we are not specifically looking the markets you mentioned in the East or in Saskatchewan. We're looking more in our major markets, but I would say within a year, we’re going to be talking about new construction at CAPREIT.

Michael Smith – Macquarie Securities

In Toronto?

Thomas Schwartz

In our markets, let's leave it at that at this point. We're at preliminary stages. Interestingly, we had a Board meeting yesterday, and this was one of the topics that I put on the agenda, so it's something we're looking at. Again, the numbers have to work for us, but they are certainly getting closer.

Michael Smith – Macquarie Securities

Thank you.

Thomas Schwartz

Thanks Mike.

Operator

Thank you, there are no further questions registered at this time. I’d like to turn the meeting back over to Mr. Schwartz.

Thomas Schwartz

Okay, thank very much. I want to thank everybody for your continued interest as always at CAPREIT and we hope to see you at our Annual meeting 4.30 Tuesday May 21, at 1 King West and as always, if anybody has any additional questions give either Scott or I a call at your convenience. Thank you very much.

Operator

The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.

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