Canadian Apartment Properties Real Estate Investment Trust

Good morning. Thank you for attending today's Canadian Apartment Properties REIT fourth quarter and year-end 2022 results conference call. My name is Forum, and I will be your moderator for today's call. All lines will remain muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star 1 on your telephone keypad. It is now my pleasure to pass the conference over to our host, Nicole Dolan, Associate Director of Investor Relations for Capri. Ms. Dolan, please proceed.

Thank you, operator, and good morning. Before we begin, let me remind everyone that during our conference call this morning, we may include forward-looking statements about expected future events and the financial and operating results of Capri, which are subject to certain risks and uncertainties. We direct your attention to Side 2 and our other regulatory filings for important information about these statements. I'll now turn things over to Mark Kenney, President and CEO.

Thanks, Nicole. Joining me this morning is Stephen Cope, our Chief Financial Officer, as well as Julian Sharpe Belt, our Chief Investment Officer. Starting with slide four, you will see that 2022 was another strong performing year for CAPRI, with positive increases across the board. Revenues at NOI both up as a result of higher occupancy, growth in average monthly rents of nearly 5% and contributions from our net acquisition activity. This drove the increase in our NSFO, which was more modest due to the impact of certain inflationary and other unexpected costs. We experienced higher repairs and maintenance costs, including catch-ups from COVID-19 related delays, as well as increased energy expenses. However, we've effectively implemented numerous mitigating programs in response, which I will expand on shortly. This all accumulated in the approximate 1% increase in our diluted NFFO per unit, despite the 0.5% increase in the weighted average number of units outstanding. Our fourth quarter results, as detailed on slide 5, show a snapshot of our improving operational and financial returns. Operating revenues and NOI were both up by approximately 7% compared to the fourth quarter of last year, while our diluted NAV per unit grew nearly 3% versus Q3 of 2022. Although diluted NFFO per unit did increase more moderately, up by 1.4% compared to the same period last year, this is This is double the increase which we realized on an annual basis. This demonstrates the beginning impact of the many cost-mitigating programs we've put in place and prioritized this year. For instance, we've refined our robust procurement practices and are proactively monitoring natural gas rates in order to hedge as much as possible. The strategic modernization of our portfolio further contributes to inherently higher margins. and we're accelerating our sub-metering and other energy-saving investments across our more vintage assets. As of year end, energy costs, approximately 65% of our Canadian portfolio, are now the responsibility of our residents. In addition to lowering costs, this also lowers consumption, contributing to our ESG commitment to enhance our environmental footprint. The increase in our same property NOA margin To 64.3%, this past quarter evidences the effectiveness of these initiatives, which we will continue to prioritize going forward. Elaborating on that strong same-property performance, Site 6 shows it's continuing to strengthen from an annual perspective as well. With significant increases in demand for quality rental accommodation, we are seeing net average monthly rents rise alongside consistent near full occupancy. Slide 7 further demonstrates the effectiveness of our highly skilled and experienced leasing and marketing teams, who have kept occupancy high and stable even throughout the pandemic, while simultaneously achieving meaningful rent increases, which are up 5% on average compared to the prior year. driver of the strong increases in monthly rents over the past few quarters is the positive trend on turnover that we are seeing post-pandemic as detailed on slide 8. We are generating unprecedented increases on turnover prior to the pandemic and have quickly returned to record-breaking increases. A rental uplift on turnover for this past fourth quarter is 24.3%, which is up substantially from the 8.6% we realized in the fourth quarter of 2021. This not only reflects a return to our normal and increasing productive sales and marketing programs, but also the worsening of the housing crisis in Canada, which we expect will continue to drive mark-to-market rent increases in the quarters ahead. I'll now turn things over to Julian to outline how we are repositioning and remodeling the quality of our property portfolio.

Thanks, Mark. Turning to slide 10, we continue to focus on increasing the quality of our portfolio through our active asset management program. Throughout 2022, our strong acquisitions team successfully added 1,537 high-quality suites and sites to our portfolio. The majority of these acquisitions were new-build assets in strong targeted geographies in line with CAPREIT's strategy of rejuvenating its asset composition and increasing our geographic diversification into desirable high-growth markets in Canada. Importantly, our acquisition of newly constructed, purpose-built rental apartments also stimulates the market for new-build multifamily assets, which represents just one of the ways in which CAPREIT is contributing to the increase of new supply in Canada. A key component of our core asset allocation and portfolio optimization strategy includes our disposition program. Our investment strategy has evolved from a focus on portfolio growth to a focus on portfolio quality. As such, we are engaged in a highly strategic capital recycling program where certain older value-add properties are being sold in the mid-3% cap rate range with the proceeds reinvested in the 4% range through the purchase of higher quality new-build properties, as well as our own trust units via our NCIB program. Many of these non-core assets being considered for disposition are attracting premium pricing and we are successfully divesting at above their IFRS fair values. As shown on slide 11, we've been selectively executing on these strategic dispositions, having disposed of almost $350 million worth in 2022. We're continuing to make active strides on this initiative in the new year, which we kick-started with a disposition of our 50% non-managing interest in three non-core properties in Ottawa for growth consideration of just over $136 million dollars. With these being our last jointly owned buildings, we now own 100% of our entire Canadian portfolio. Not only do these strategic dispositions enhance the quality of our overall portfolio, but they also result in disposition gains and a highly attractive source of new capital to fund our more creative capital deployment priorities. One of these priorities is the NCIB program that I mentioned. This represents a critical cornerstone of how our capital allocation strategy, and slide 12 summarizes how we've been doing this. By selling non-core assets at or above NAV and repurchasing units at a major discount to NAV, we are arbitraging the significant spread and realizing immediate value for our unit holders. To date, CAPREIT has invested over $245 million in our NCIV program, with a purchase of 5.4 million units at an attractive average price of approximately $45 per unit, which is well below our $58.01 year-end net asset value per unit. We will continue to stand by Capri's strong fundamentals and invest in our own portfolio of increasing quality as long as it is prudent and economical to do so. Slide 13 showcases the real progress we've made on repositioning our portfolio to reduce our exposure to older value-add properties while increasing our allocation toward new-build, more modern properties. In successfully upgrading our portfolio in this way, we've not only improved its quality, but have also diversified our tenant base and geographical exposure in specifically targeted, underrepresented markets. We additionally improve our margins given the high growth profile of these newer assets, coupled with the lower operating costs that result from enhanced energy efficiency and submetering. Lower capital expenditure needs also reduce our exposure to inflationary pressures. In summary, we are strengthening our environmental and operational performance and ultimately enhancing our risk-adjusted return profile. Thank you for your time this morning, and I will now turn things over to Stephen Coe for his financial review.

Thanks, Julian, and good morning, everyone. As you can see on slide 15, our balance sheet and financial position remains strong and flexible at year-end, with a conservative debt to gross book value and continuing high liquidity. Our $1.3 billion in Canadian unencumbered properties provides additional liquidity should it be needed. In total, if we were to access all of our available sources of debt capital, we would have up to approximately $1.2 billion accessible at year-end. Looking at our financings through 2022, we locked in favorable interest rates on our refinancings and extended our term to maturity. Based on our current property portfolio, we expect to refinance between $750 million and $800 million in mortgages and top-ups in Canada in 2023. Our disposition and capital recycling initiatives further supplement our debt program. by enhancing our ability to proactively manage and reduce our reliance on debt. Slide 16 demonstrates our success at controlling interest costs in Canada. In fact, our strategy to leverage 10-year CMHC insured mortgage debt has resulted in CAPREIT having one of the longest terms to maturity and lowest weighted average interest rates among our publicly traded peers. This provides us with strong protection against renewal risks, especially in the context of the current interest rate environment. Importantly, nearly all of our mortgage debt carries a fixed interest rate, positioning us well to continue mitigating the impact of future interest rate volatility. Diving deeper into our mortgage portfolio, you will see on slide 17 that it remains well balanced over the next decade, with no more than 15% coming due in any given year, which again reduces risk in this volatile interest rate environment. Looking ahead, we will continue to take an active approach to debt management and thoughtfully renew and top up our mortgage financings to optimize our overall debt and liquidity profile. To that end, with current 5-year and 10-year all indicative rates both at approximately 4.3%, we will consider availing of relatively short terms upon renewal of our more imminent mortgage maturities with a view to minimizing our interest costs over the longer term. Further to our healthy financial position, you can see on slide 18 that we have consistently met our goal of maintaining very conservative debt and coverage ratios, even through the pandemic. This conservative approach underpins the stability and resiliency of our business and the sustainability of our monthly cash distributions to unit holders. Our focus on maintaining one of the strongest balance sheets in our business will continue going forward. I'll turn things back to Mark to wrap up.

Thanks, Stephen. Looking ahead, we continue to see a number of very positive value drivers that we are confident will generate strong and growing returns for our unit holders for the years to come. We will continue to actively execute on our proven investment strategy, which is summarized in slide 20. First, on the apartment front, we will seek to continuously heighten the quality of our portfolio by disposing of our non-strategic value-add properties and reinvesting in more modern, newly built properties located in high growth and diversifying markets. Yields are attractive, growth is strong and stable, margins are higher, and capex is modest. Our second focus is on our NCIP program. As long as our unit price remains disconnected from the strong pricing we see in all of the private markets, we will continue to crystallize and spread and secure instant value creation for our unit holders. The third pillar of our capital redeployment program revolves around upgrading our debt profile through de-levering or delaying refinancings in this highly volatile interest rate environment. Our asset-light development model also plays an important role in our strategy, and we are actively working through zoning processes in order to serve and monetize our excess land, which generates additional funding for us to allocate towards CAPRI's core competencies. Our ability to capitalize on the increasing favorable fundamentals in the market will further stimulate our growth. Canada's housing supply and affordable housing crisis are front and center. There are simply not enough homes, and the homes that we do have are just not affordable for Canadians to purchase and own. This alone driving demand for rental accommodation to historic highs. On top of this, we have a host of additional factors that are further fueling the fire. Accelerating immigration is in particular compounding the crisis. While the post-pandemic return to the workplace and in-class learning drives the incremental household formation and demand, demographic trends are fracturing in as well, including delayed family formation, seniors independently living longer, and overall smaller household sizes. Magnifying all of this is the fact that the cost of build is skyrocketing. which is significantly hindering the increase in new supply needed to address this unprecedented demand. As you can see on slide 22, these demand drivers are resulting in rental growth across all age groups in Canada. In fact, renters have increased at three times the rate of home ownership over the last decade. Supply and affordability pressures, demographics, and a preference to renting especially in the real estate market, currently fraught with uncertainty, have driven this growth and will continue to do so in the years ahead. We also continue to extensively invest in our core portfolio, generating a number of key benefits as outlined on slide 23. Our energy saving initiatives and technology upgrades reduce our costs and improve the operating efficiency and environmental performance of these properties. That in turn contributes to our ESG commitments. Our focus on enhancing the safety of our residents further increases the attractiveness of our properties and the satisfaction of our tenants. Finally, as I mentioned earlier, Canada is experiencing the worst crisis of housing supplies and affordability in a generation. and is one of the largest publicly listed providers of quality housing, CAPREIT is a key part of the solution to Canada's housing crisis and has taken a leading role in that discussion. Along with our peers, the other large publicly traded Canadian residential REITs, CAPREIT has led the launch of the Canadian residential housing providers for affordable housing. This coalition has advanced numerous proposals to address issues around additional housing supply and affordability in Canada, some of which are outlined on slide 24. One of our objectives is to educate policy makers and the public and do a bit of myth busting in order to ensure that workable solutions are informed by facts and evidence. For example, the fact that a publicly traded residential REIT represents less than 3% of Canada's rental market or the fact that over half of our suites are rented at rates that meet the government's definition of affordable, or even the fact that CAPREIT has never done a rent eviction in its 25-year history. With our experienced Senior Vice President of Tax and Government Relations, CAPREIT has been working hard on many fronts to effect meaningful change, and we have engaged in productive dialogue with a variety of government officials. Most recently, we enthusiastically welcomed BC Premier Eby's announcement of a $500 million rental protection fund, having been strongly advocating for a government-led acquisition program as one of the most cost-effective ways to preserve existing affordability in housing. From our vantage point, we are both hopeful and optimistic that we will see constructive policy announcements in the near term. This past September, we celebrated 25 years of strong performance and value creation. Since inception, CAPREIT has grown from owning only 2,900 apartment suites in Ontario to closing out 2022 with interest in almost 67,000 suites, townhomes, and manufactured home community sites, which are well diversified across all major Canadian markets and internationally. Our total investment property portfolio now exceeds $17 billion. From the beginning, our goal at CAPRI is to provide a safe and pleasant rental housing experience, second to none in our chosen markets, and we believe that we are meeting this objective. By building a modern, high-quality portfolio, investing in our property, and leveraging the significant experience and commitment of our team, we are confident the next 25 years will see further value generation for all of our stakeholders. In closing, we remain very excited about our future. Moving forward, we will seek to actively upgrade our property portfolio on a perpetual basis. One, by targeting the acquisition of new-build properties in Canada's strongest markets. And two, by strategically disposing of select non-core value-add assets. Our divestiture program will also remain focused on unlocking and monetize development value from excess density. We will additionally use net proceeds from this capital refresh strategy to proactively manage our debt profile. We're prudent. We will also invest in our NCIB to convert that growing portfolio quality into immediate returns for our unit holders. Responsible monthly rent increases and consistent near-term full occupancies will further contribute to higher revenues, as will increasingly strong fundamentals in the Canadian market. We are confident this will all result in Capri's continued ability to generate strong and growing returns for the foreseeable future. Thank you for your time this morning, and we would now be pleased to take any questions that you may have.

Certainly. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. Our first question comes from the line of Mark Rothschild with Canaccord. Mark, your line is now open.

Thanks. Good morning. Maybe just talking about the capital recycling and looking at how you're trading out of maybe some older properties into buying newer. Does this analysis also go into geographical decisions or is it really just based on the types of properties? Like, for example, certain markets in Canada having stronger population growth than others, maybe job growth. Are you looking at it that way? And maybe just expand on that and how you look at different markets.

I'm going to let Julian touch on this, but I would say because of our reputational placement in the market coast to coast, we look at all appeals in the markets we're interested in. The best new build opportunities for us are properties that are nearing construction completion or recently finished, so that really does limit the pool. So calling it a specific market would be hard to say. on the markets that we're familiar with, we get the yields that we're seeking, is definitely objective. Julian, why don't you add to that?

Yeah, no, what you said, Mark, is exactly right. We're limited in what we can buy and what's out there to bid on, but certainly there's markets that we have greater appetite for and we'll target a little bit more if we can. Things that do drive our views on that is, are we waiting in that market? Are we underweight? Are we overweight? Is there forecasted strong population growth, forecasted strong economic growth? Is there a lot of supply? Where is the supply-demand imbalance most acute? We factor all of that in our bidding process.

Maybe just to clarify a little bit what I'm trying to get at is, Besides from buying new, when you look at markets, let's say Halifax or Alberta, where fundamentals might be changing a little different than Ontario, would you buy older properties there if you see better rent growth? If you could just talk about how you look at the Alberta market now.

No, we're pretty much exclusively focused on the new-built assets right now. Our appetite is significantly stronger for those, but certainly within those markets that you described earlier, where we do see very strong fundamentals, you'll see us have a bit stronger appetite than in others. Okay, great.

One thing, Mark, just to be clear, we have come across situations where there's a brand new bill that's attached to a value-add property. You may see unique situations where we deviate from the strategy, but not in a conviction to value-add, just where it makes absolute sense when we own something or have to buy something together. So it's not exclusively a moratorium on not buying value-add, but it's really a focus on new construction.

I got it. Makes sense. Thank you.

Our next question comes from the line of Dean Wilkinson with CIBC. Dean, your line is now open.

Thanks. Morning, guys. I'd actually like to continue on that same vein of the new construction. Mark, do you think that the ban on foreign investment causes new construction, in particular maybe your desire to construct new, to become a bit of an unintended consequence there? What do you think the outcome of that ends up being?

I think there's going to be I think this issue has to get shaken out of government. The intention was not to stop rental development. We've had conversations with government. I suspect that the implications will be better understood in the short term. I'm optimistic on that front. I think what it does for CAPRI is it could create an opportunity with near completion rental products that are attracting less capital that could make financing and value a little more compelling. So in the short term, I think this is a blip, and it's one that we will take advantage of if we see opportunities in the marketplace.

Dean, one thing I've heard theoretically, and we'll see if it pans out, is if there's less demand... When folks have a development site for residential, there's always a decision, do we do purpose-built rental or condo? To the extent that this theoretically lowers demand for condo, there's a possibility they would add more to purpose-built rental, but we'll see if that actually pans out that way.

I can't help but throw this on the table. We all are very aware that in the large Canadian cities, the primary supply of rental has come in the form of condominiums and borne by buyers. funding the purchase of those condominiums. Now if that softens the demand of really the rental sector as we knew it over the last decade, that will further exacerbate the problem in the marketplace. Like quite bluntly, most of the rentals in Toronto have been condos that were bought by foreign investors. And if that ban sticks at that level, We're in for even more rough waters with respect to getting supply to market. So these are the unintended consequences that I think have to be thought through carefully by policymakers.

Yeah, I guess it's a bit of a moving target and they don't know what they're shooting at. And then the other question I had was just on that big lift on the sweet turns. Do you have a sense of what the duration of those tenants that... turned the swoop back to you was during the quarter? And is that sort of a number that we can think about sort of as a new baseline?

Well, historically, we know that higher rents generate higher turnover rates. People don't hold their leases back like it goes away. We are not seeing any evidence of this at all in the churn. If you look at the early innings here, the churn is basically unchanged. So even with these higher rates, we're not seeing an increase in churn rates. So we'll see, we'll see. Yeah.

Our next question comes from the line of Jonathan Kelcher with TD Securities. Jonathan, your line is now open.

Thanks, good morning. Just to follow along, So do you think for 2023 you can continue to get sort of north of 20% uplifts on turnover?

Well, I caught myself stumbling at the end of that sentence to allow your question, but what I was going to say is that we're bumping up against the ceiling of affordability. I wouldn't expect to see the chart continue to accelerate at this pace. Jonathan, if you look at the, I think it might be slide 18, that shows the kind of the sector in the pandemic, it's exactly what we were telling the market in terms of the household consolidation impact, the lack of foreign students, all these factors resulted in a massive, massive reduction of market-to-market rents in the 3% range. so when you draw the line pre-pandemic to where we are right now it's just a steady increase that shows the supply problem um happening it's not a marked event it's exactly what was going to happen in the market had the pandemic not happened we lost three years in in the supply conversation because it appeared on paper rents were falling and vacancies were abundant But it was because everybody was in a consolidated household, and we stopped the flow of foreign students. So we're just back to a normalized chart here that you can probably, using the ruler example, you can probably just predict quite on a stable basis now where this line is going. It will moderate.

Okay, but you've got a lot of catch-up, right? Your mark-to-market's got to be... 20-25%?

I think the evidence of the actual rents are saying 20-25%, that's for sure. You know, I don't believe in this mark-to-market rent business. The mark-to-market rents are what we posted last month in terms of what we actually achieved. I think that at these occupancy levels, we're going to have a very hard time getting at the upside, but the demand is astonishing.

Okay, and if we flip to expenses, what are you guys thinking for expense growth for 2023?

Yeah, so in Q3, I kind of said that we're expecting for 2023 around 4% or 5%. I mean, looking at the weather that's been occurring in January and February, a lot of moderate weather. I think we're probably on the lower end of the range.

uh so yeah i think that's that's kind of where we're still guiding four to five percent um and all on the consolidated opex area but um maybe on the lower end if anything i i think we've been talking obviously a great deal about the joel's experience with repairs and maintenance a whole variety of factors that conspire to date just you know from one quarter to the next uh the team feels very confident that the worst is now behind us and inflation is baked into the actual expense lines. We wouldn't expect to see inflationary jewels. We don't expect to see catch-up jewels. We don't expect to see a number of the factors that we sadly encountered during the last few quarters.

Okay. Sounds good. I'll turn it back. Thanks.

Our next question comes from the line of Mario Sarik with Scotiabank. Mario, your line is now open.

Hi. Good morning, guys. Just sticking to the OPEX, I appreciate the color on maybe the cost coming in at the lower end of the 4% to 5% range, primarily due to the weather. When comments were made back in Q3, were they made inclusive of the notion that you were reviewing the cost structure going forward? I'm just curious whether the 4% to 5% is still quite conservative in your view and whether there's the possibility to kind of surprise to the upside on that based on recently implemented initiatives.

Yeah, I mean, that's kind of on a stable basis. I think we have, as Mark alluded to in his script, there's some procurement initiatives that we're undertaking within OpEx. There's also some of the... you could say MH type of maintenance costs that we incurred in 2022 that we hope to have resolution on in 2023. So that may help as well. So four to five is kind of stable state without any type of, you know, efficiencies that we were going to build in. So to your point, it could get lower if we can initiate on those and execute on those.

Got it. Okay. More of a bigger picture question, just sticking to operations, like the top line revenue growth is getting stronger. You're making a bit of progress on the expense issues that you documented, so it's really driving much better same-star and wide growth for this quarter than what we saw for most of 22. That said, the recurring FFO was kind of flattish, up 1% year over year. So the question really pertains to your thoughts internally on your ability to convert what appears to be

strongly improving seams to rely growth and to improve the ffo growth per unit in 23 relative to what you did in 22. yeah listen we have a track record that was disturbed by some quarters of uh you know unfortunate one-time events and uh in a 25-year history you're going to hit these patches and we sadly hit it but we're very confident that we we're back to normal state and catherine's proven itself over the decades now to be highly effective at cost control and highly effective revenue yield managers and there's just incredible incredible excitement around around not just the expense growth but you know a more normalized capex then as julian continues on the path of purchasing newer high quality assets they have that attribute of lower capex that results in lower jolts to the system especially in a world where you know our interest rate carrying costs on those capex investments are quadruple what they were two years ago um our strategy fits perfectly into that as well so like we're in uh really quite exceptional um uh state here now it's been a very difficult Three years for CAPRI, we managed occupancy exceptionally well. We did not know how long the pandemic was going to last. I stick to our strategy of minimizing vacancy effects. And our strategy is working exactly as we had planned. We're coming out of the pandemic. It's exactly what we called in terms of demand throughout the pandemic, with household consolidation. And the team is fired up. I get ready for more savings for Capri.

Got it. Okay. Two more quick ones on my end. I don't know if you'll have this number, but the 24% new lease spread is much stronger than the 14% in Q3. Do you have a sense of what the average cost per suite to turn was this quarter versus last quarter?

No change. If anything, we're seeing slightly lower costs to renovate because the market is just there with or without the renovation.

Okay, that makes sense. And then lastly, just for maybe Steve, just pertaining to your comment on maybe going shorter term on the debt, on refinancing, what kind of term are you thinking and where would the cost for that term B today in relation to the 4.3% for 5 and 10-year money that you referenced?

Yeah, I mean, 5 and 10-year money is pretty much at 4.3% for CMHC financing. I mean, it all depends. I mean, I have a constant conversation with Julian where he has disbilled proceeds and where my line of credit is sitting at maybe like 5%, 6%. That's a pretty good use of proceeds and paying down the line. So it's really, you know, it's a moving target in some ways or a moving strategy in how we deploy those proceeds. So if we don't need to, if the maturity is coming up for a mortgage, I may actually just not renew or we just pay down the debt. So it's all dependent on what Julian can do. So it's really a more active debt management strategy.

And, you know, it's an opportunity to highlight The investment teams work here. We are absolutely focused on a delivering strategy. And if we can continue to generate dispos in the three cap range, you don't have to be a mathematician to know 6% on a revolver is a heck of a good use of that 3% use of proceeds. So we've got a lot of instant ways to deploy capital. Between our NCEIB program, our delivering exercise in the acquisition market, we are sitting on unbelievable instant use of proceeds.

Got it. Okay. But just for clarity, like outside of the recycling, just in your normal course, kind of debt refinancing, like when you talked about going shorter term, were you referring to the five-year debt or were you referring to something shorter than that?

No, I'm referring to five-year, or I can use the revolver, but it's likely going to be the five-year.

Got it. Okay. Great. Thank you, guys.

Thanks.

Our next question comes from the line of Brad Sturgis with Raymond James. Brad, your line is now open.

Hi. Good morning. Just on the disposition program, obviously you you've been quite focused on the value-add assets with intensification potential. I'm just curious, does that program or analysis expand into looking at smaller markets where maybe the returns aren't as favorable or the regulatory environment's changed where it may not allow for capital allocations in that market? I'm just curious if we'll continue to see more of the kind of urban markets value-add assets being sold or your analysis or opportunities to sell out of other smaller markets?

Brad, we're really open to selling anything that's not performing well or where we don't see good future returns. And so there are some markets that have been subject to worse regulatory regimes or that have less population growth going forward or that have more supply than other markets. And so We're really combing through the entire portfolio, looking at the risk-adjusted returns of all of our assets and where we see strong or at least decent demand. And that's how we're kind of filtering through it and picking what we're going to dispose of.

Just to build on it, Brad, we built out in the investment development group a fine group of talent, which is really now focused on asset management analysis. That really kicked into high gear, I'm going to say almost six months ago. And as Julian said, we're agnostic to markets. It's all about performance at this stage. We have great conversations now about future outlook, top performance, and really just being completely agnostic to the real estate and focused on yield.

Okay. And it sounds like you're still seeing that cap rate spread between what you can sell and what you can buy. So, you know, at least 100 basis points between the two.

Well, it's so low, it's such a low, like, I'll let the guys chime in, but I can't help myself. When you're talking three caps, see, Stephen's got six on the revolver, Julian's got four and a half caps in new construction, and we got an NCIP program that can also juice returns. So, it's an incredible situation. We use proceeds, they're not our problem.

Yeah, Brad, that won't necessarily preclude us from selling stuff that are higher cap rates if there's no growth or heavy capex burdens or really onerous regulatory regime in the area. So you'll see some of those as well. We are really focused on total returns, not just the cap rate, but factoring in the capex, the growth, and other considerations. But generally speaking, that is what we're seeing on the disposition front versus tighter cap rates than what we're buying.

And, you know, with the Ottawa sales executed, I assume that was initially used to repay the line, but assuming that eventually gets redeployed into new build acquisitions. Yep. That's a good assumption. Okay. And then the opportunity that you were reviewing on the, on the disposition side, that's still call it around the 600 million mark in terms of, potential assets that could be under consideration?

Yeah, for the year, if I could do $500 million. I mean, it's all market dependent, and we're in negotiations on a bunch of different things, and we're working through it. But if I could get another $500 million or $500 million for the year, we would view that as positive.

We've also absolutely led the charge, as we said in the presentation, of on acquisition fund opportunities. So we're in active dialogue with the province of British Columbia and very much offering up ways to help with the federal government. So should there be announcements on that front, that could accelerate opportunity on the disposition front, but we're not factoring that in. that range, we're hopeful that the private market will deliver that. I got to point out though, the team works very, very hard and the dynamics of selling in this market to the private market, it's a different profile of buyer. We're talking about private ownership. So deals are really never deals until closing one minute after closing date. So that's the environment that we're in, but it's worth the effort and the team's doing a great job. And we're very, as I said, extremely excited about the exercise we're going through.

If you were to contribute to that BC initiative, would that be tied to, I guess, a third-party appraisal? And then would you, does it sound like to you or based on your discussions, do you think there's appetite either in other provinces or at the federal level to do a similar type of initiative?

There's been announcements in Toronto for a very, very small scale, like $60 million or something, but this idea is taking hold in provinces, in municipalities, and at the federal level. Our commitment is, of course, as always, to our unit holders and value in that regard, but we think we can strike that balance between protecting unit holder value and doing some good for Canada, and as leaders, that's our responsibility. That's why I've been so vocal on this front is, you know, the notion of being able to buy buildings at, you know, 40% of replacement costs, something government needs to understand. We're trying to help them understand that.

Okay. Great. Thanks, Phil. I'll turn it back.

Our next question comes from the line of Kyle Stanley with Desjardins. Your line is now open, Kyle.

Thanks. Morning, guys. Just looking at your turnover spreads again, I'm just wondering, you know, the level that you achieved in the quarter, would you say that was more reflective of just underlying market fundamentals? Or, you know, would you say there's been a strategic shift or focus on kind of pushing rate a little bit more within the organization specifically?

Yeah, no, it's definitely market dynamics. Certainly, we're always focused on maximizing value for our unit holders, but this wouldn't be unique to cap rate. I mean, the whole market's really been experiencing pressure. As we've alluded to, it's a very large population growth matched with a shortage of new supply being added.

And when you blend in, this is also on a small number of units as well. We get caught up in the headlines, but when you look at the total rent increase passed on to Capri customers, in-place customers, we're talking sub-2%. So this is what's helping offset the market. But Julian makes a very important point that I touched on in the slide presentation, is that all the REITs in Canada combined are, I think it's like we're sitting at about 2.6% of the market with our dispo. We're a very, very, very small sample of the Canadian market, but reflective of what's happening in the markets that we're in.

Right. Okay. Thank you for that. Just digging into performance, just from some key geographies, would you be able to comment maybe on the OPEX improvements you saw in Montreal, Halifax, and Vancouver? It seemed like the strong, say, proper NOI growth. obviously accompanied by strong rent growth, but it really seemed to be OpEx driven. So just wondering maybe what drove some of that.

We had, in a more remote geography, I think we said it throughout the pandemic, Montreal was really hit quite hard during the pandemic. We had definite staffing challenges there and we've got new leadership and really rebuilding the team there in Quebec and it's having great results. So I think we had some operational challenges. You know, from a margin point of view, the expenses show up because rents are lower. But we're feeling, you know, very, very good about where we're at with the team in both the east and in Quebec.

Okay, great. And then just one last thing for me. Just on the... the septic issues within the MHC portfolio. I'm just wondering if you could comment on, you know, to provide an update, I guess, on where we stand currently.

Yeah, I'll pass through on what we're trying to do, but the reality is, you know, I think we have to own the problems that we've learned through older communities. The septic systems were in the 50-year range. It all had to do with hauling costs. We had just another you know, tragic coincidence of three sites at the same time, but why don't I pass it over to Julian to help share what we're doing on that front.

Yep, so we've been looking, we've been working with the ministry and with some of our vendors to mitigate or lower the hauling costs as much as possible, and on my end, to the extent that I can do it effectively, I'm going to look to dispose at appropriate values some of the worst offenders. It's certainly tough assets to get liquidity on, but it's something we're exploring and making sure that we do at prudent price levels.

I would also just add on that front that the high grading of the CAFRE portfolio is moving into our MH sector as well. We love this sector, but we're taking, with the help of our asset management team, team a much closer look at returns. The tradition is to love the sector. Now we're looking to love the returns. So more refinement in total return will help drive the high grading of the MH portfolio as well.

Okay, great. Thanks for the caller. I will turn it back.

Our next question comes from the line of Jimmy Sean with RBC Capital Markets. Jimmy, your line is now open.

Thank you. So Mark, I think you mentioned that the market rent that was achieved this quarter on turn is starting to hit the affordability ceiling. Do you have a sense of what the rent to income ratio would be on your tenant base on those turns?

That's a great question. And a lot of this is going to depend on the profile of the asset that we own. So if you look back, we can get you the slide deck, but we had a deck, it might be in our investor relations pack still, that shows that the income to rent ratio in our portfolio is around 25%. This is incredibly, incredibly affordable. And this is the point that we continue to make on how affordable the portfolio really is. When you've got home ownership ratios at 70, 80%, in the big cities, Capri portfolio in major markets was 25. So that 25 is now moving up into the low 30s, but it's still exceptionally affordable. So, you know, in the assets, so this is a bit of a thread the needle and understand the difference between the new portfolio and the old. If you're buying those value-add assets, you're targeting certain income brackets, those will bump up against affordability ceiling much more quickly than the brand-new high-quality luxury assets where family incomes are probably in the plus $200,000 household range. So it really is not just a sector. It's a tale of two different sub-markets within a rental universe.

Okay. But based on your comments that given the terms that you've seen this quarter and especially the value, I assume a lot of the 24% would be on the value type of assets that you're hitting that ceiling and that your expectations for the market rent on those particular assets, they don't have that much more room to grow. Would that be fair?

24% is a lot of growth, but yes, is 24 going to turn into 30? Probably not. If you look at the slide deck where I think Julie was talking about the percentage of the portfolio value, I think we were at 86%, if I go by memory, value-add, 9% new construction. We're going to keep tilting that, but 86% is still value-add. This is what's 100% driving the big mark-to-market gains. But then the offset to that, Jimmy, you heard us talk about the margins in the newer buildings are much higher. So you don't have the inflationary exposure in the new construction assets that you have in the value-add, but you have higher market markets, and you don't have the capex, and the list goes on that we've allocated as to the rationale for the strategy.

Right. Okay. And then just on the natural gas hedging, I think you said 70%-ish in hedge. How would that compare, the rate compare with the average of 2022?

Maybe I'll have to look into that, Jimmy, and maybe I'll take that off along with you.

Okay. Okay. That's it for me. Thank you.

Our final question comes from the line of Matt Kornack with National Bank Financial. Matt, your line is now open.

Good morning, guys. It would be hard to believe that it would exist, but are there any pockets of weakness still within the portfolio at this point, or is everything kind of running on full steam ahead at this point?

Yeah, no, it's... All markets are covered. The area of focus for CAPREIT is around some select lease-up assets, newer construction lease-up assets in Montreal. But they're completely on target. That is for sure. So we don't see any trouble in the actual market itself. Sure, a challenge, though. that we're now very much aware of. As we high-grade the portfolio, you don't have to, again, be a mathematician to know if you're selling value-add bills and buying brand new construction without using the NC, before the NCME or paying down debt. The portfolio's getting smaller, and so we're gonna have to manage G&A as we go forward here. We've got, I believe, one of the most spectacular resi teams in North America, and we've gotta preserve that team as the portfolio gets smaller. And so that'll be a headwind in maybe two to three quarters from now if all goes to plan on the DISPO front. We have to manage that. So these are things that we're working through, that we're aware of, and we've adjusted to most of the cost increases in G&A at this point with salary adjustments. Those are now behind us. And now it's just managing the team. for a smaller portfolio for the effects of G&A.

Fair enough. Also, this quarter was pretty heavy on the CapEx front. I think it was in line with your budget for the year, but have you thought to or provided any guidance on 2023 CapEx expectations?

No, I think we were conscious that and putting around like a CapEx budget. What we did provide was, I think, more of an estimate in terms of the non-discretionary CapEx. As Marcus kind of alluded to, you know, in-suite improvements, given the very, very strong rental market, we may be able to scale back on some of that CapEx spend. But areas that we will focus on, that we will put a lot more money into, is the energy and conservation area. That way we can reduce some of the utility costs or even reach some of our ESG goals in terms of energy.

Okay, fair enough. And I think this quarter was the lowest turnover you've ever had in at least post-financial crisis as far as our data goes back. So presumably the opportunity set on suite renovations may be a little lower as well. Is that a fair comment?

That's an absolutely fair comment.

Okay. Just a quick one, Stephen. On the interest on bank indebtedness sequentially, is there anything in that? I would have thought it would have gone up, but it went down. And I know there's some consolidation stuff with E-RES, so I'm not sure exactly how it works on the financial statements, but any comment there?

Yeah, Matt, maybe I'll look into that and we'll take the offline.

Okay, sounds good. And then the last one for me starts were fairly elevated. I'm not sure for purpose-built rental during the pandemic when financing costs were exceptionally low, but it seems like they're falling off a cliff. And I don't know, the few purpose-built rental entities in the public markets seem to not think the numbers make a lot of sense to start projects right now. So Can you give us a sense as to, A, how you think that ultimately impacts the existing rental market, but also the opportunity set to buy some of these newer assets? I presume you'll have deliveries, elevated deliveries through this year, but they may fall off thereafter.

We're acutely aware of that problem. There may be short-term distress, is all you're saying, in the market right now. That might represent an opportunity for cap rates. to take on some of these projects. We've got underneath this, Gillian can talk about it a bit more, but we're making tremendous strides on the entitlement front and hopefully those entitlements will be in place at the perfect time, call it three years from now. So Capri, again, I'll let one of you talk about our development program, what we're doing, Gillian.

Yep, so we're working through combing through the portfolio and identifying excess land and there is a significant amount of it and going through the entitlement process and really trying to maximize the value of that land that doesn't really show up in our IFRS value and take that cash and redeploy it into our core competency of acquiring and operating apartments. To touch a little bit on what you were saying earlier there, It is something that we do see as being a problem for the supply of purpose-built rental going forward. The economics of developing apartments is becoming more and more challenging, given the higher cost of development and, frankly, the still problematic entitlement process. And so while we are still seeing new supply, there is a a very real possibility that that starts to drop off as projects now become more and more challenging to launch. While that could potentially present a problem in acquiring more assets, on the flip side, it also will make the constrained supply even more constrained and drive higher rental growth. It's a double-edged sword.

I guess taking that one step further, let's say we get to 2025, interest rates are a bit lower and we have a significant need for new rental and people can start again. Would you be inclined to build on your book at that point or sell the excess density so that someone else can build?

Hard to say what we'll do two or three years out from now. We are in the business of acquiring and operating apartment buildings. It's not to preclude us from doing anything in the future, but we'd really evaluate it in the context of where we can deploy our capital, how much capital is available to us, what our risk appetite is at the time. But for now, for the foreseeable future, the strategy is what it is.

Matt? We saw some merchant rental builders enter the market really starting five, seven years ago. And these are the projects that we're now seeing available in the marketplace that we've been acquiring. And it is an incredibly unfortunate situation that we are where we are right now because really what's happened now is going to determine what happens four or five years from now. But I can't help but go back to what Julian said looking two or three years out. All I know and all we know here is that CAPREIT has an apartment portfolio that is bigger than all of our peers combined at a time that we have unbelievable use of proceeds. So we are so anxious to monetize the value of some of our lower tier assets because we have this use of proceeds, whether it be NCIB, de-levering, or buying some of these luxury new builds that we're seeing in the marketplace. All we can say is right here and now, it's never been better in terms of the capital recycling opportunity. So that we're very, very focused on. We're also very, very focused on unlocking finally the value of some of the land and the team is making some great strides in that area. And that will be the repositioning that will set us up I think incredible opportunity three years, whether it be selling that land, developing that land, maybe it's developing it for condos. It's hard to say right now. It all depends on the environment at the time, but we're definitely setting ourselves up for success in the next three to five.

That absolutely makes sense to me. Thanks, guys. Appreciate it.

Thanks, Matt.

This concludes our question and answer session for today's call. I will now pass back to Mark Kenney for any closing remarks. Thank you.

I'd like to thank everybody for their time today. If you have any further questions, please don't hesitate to contact us at any time. Thanks again. Have a great day.

This concludes today's Canadian Apartment Properties REIT fourth quarter and year-end 2022 results conference call. Thank you for your participation. You may now disconnect your lines.