Dream Residential Real Estate Investment Trust

Welcome to the DREAM Residential REIT second quarter 2024 results conference call on Thursday, August 8th, 2024. Please be advised that all participants are currently in a listen-only mode and that the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star then zero. During this call, management of DREAM residential REITs may make statements containing forward-looking information within the meanings of applicable securities legislation. Forward-looking information is based on a number of assumptions and is subject to a number of risks and uncertainties, many of which are beyond DREAM residential REITs control. that could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking information. Additional information about these assumptions and risks and uncertainties is contained in DREAM Residential REITs filings with securities regulators, including its latest Annual Information Form, an MDNA. These filings are also available on Dream Residential REIT's website at www.dreamresidentialreit.ca. Your host for today will be Mr. Brian Pauls, CEO of Dream Residential REIT. Mr. Pauls, please proceed.

Good morning, everyone, and thank you for joining us today for Dream Residential REIT's second quarter 2024 conference call. Speaking with me today are Scott Schumann, our Chief Operating Officer, and Derek Lau, our Chief Financial Officer. We were pleased with our financial and operational performance for the quarter. The REIT delivered strong comparative properties NOI growth at 6.8% year-over-year, primarily driven by higher rents and completed value-add renovations. Year-to-date comparative NOI was 5.1%, or at the upper end of our 3% to 5% target for the year. Comparative properties NOI margin increased to 52.6%, which is an increase over both prior quarter and the prior year comparative quarter. FFO per unit was 18 cents, representing 1.8% growth from the prior year while having one less property. Occupancy increased 20 basis points quarter over quarter, and average in-place rent of $1,167 per suite represents growth of 1%, from Q1-24 and 4% year-over-year. During the quarter, we achieved blended lease trade-outs of 2.2%, driven by 3.7% spreads on renewals. We completed 64 renovations across the portfolio with another 16 under construction as of the end of the quarter. For Q2-20-24, average lease trade-outs on renovated suites was 7.5% compared to a decrease in classic suites at 1%. Despite better than expected renovation costs, we are seeing ROIC fall below our targeted range of 12% to 16%. We constantly evaluate the value-add program, and as a result, we are updating our targeted renovations for the year to 200 suites. We will continue to monitor the pace of renovations and maintain financial and capital flexibility to accelerate or further moderate if required. Overall, Q2 2024 was a solid quarter. While investment volumes are down across the board, we are seeing stable asset values in attractive markets. We note that sentiment on the future interest rate environment is positive, and we are cautiously optimistic that this will benefit the entire multifamily market. I will now turn it over to Scott to provide an operations update for the quarter. Scott?

Thank you, Brian. We are pleased to report $6.4 million quarterly net operating income firmly within forecast expectations. Inline revenue paired with disciplined expense savings to drive 52.6% NOI margin and 4.2% year-over-year absolute NOI growth up from Q2 2023. Comparative property NOI improved 5.1% year-over-year through the first half of the year, 6.8% year-over-year for the second quarter, and 4.6% higher than last quarter. Occupancy ticked upwards to 94.0% on June 30th, 2024. This advanced 20 basis points above last quarter and finished equivalent to June 30th last year. Cincinnati occupancy held steady with Q1 at 94.9%. Dallas-Fort Worth and Oklahoma City occupancies both edged higher than last quarter, higher than last year, and higher than the trailing 12-month average. This data reflects our focus on renewals stabilizing operations, and moderated numbers of suite renovations. DRR portfolio and regional occupancies continue to better comparative national and regional benchmarks, even with ongoing value-add construction. Leasing conditions improved during the spring, but continue to reflect the temporary conditions of oversupply nationally and notably across the Sun Belt. Asking rents are volatile week to week and month to month, but blended lease tradeouts rose 20 basis points from Q1 up to 2.2%, driven largely by 3.7% renewal tradeouts and a 59% renewal rate. As a result, in-place rents grew to $1,167, 1% higher than last quarter and almost 3% higher than last year. Dallas-Fort Worth in-place rents held positive for the quarter and the year, while our Cincinnati market continued to exhibit nation-leading strength with 5.3% year-over-year in-place rent growth. In the current environment, we have moderated the suite renovation program in favor of renewals and stabilizing operations during this historic but temporary period of elevated new supply deliveries. Construction teams completed 64 suites during Q2, with renovations ongoing in all three operating regions. Year-to-date, we have completed 98 renovations and have revised our end-of-year target count to 200 suites. Lease-to-lease value-add spreads are positive relative to Classics, though they are moderating and are below our target range this calendar year. Our construction teams have renovated 734 suites over the past two years, with an average return on invested capital on the high end of our target range. Our near-term plan is to regulate suite construction investment in order to retain platform capability such that we prepare to re-accelerate value-add work when conditions are more favorable and returns are advantageous. Our washer-dryer appliance value creation program continues. We have installed 56 sets year-to-date and average a 50% return on investment. Across the market, we are seeing cap rates stabilize, but transaction activity remains comparatively subdued outside of several large headline institutional trades. Underlying apartment demand is healthy, and appears durable beyond the temporary supply wave. Near-term rent growth will be conservative, but confidence in values is rekindling. Future renter demand looks to be strong. It is my pleasure to turn over to Derek Lau, our Chief Financial Officer.

Thanks, Scott, and good morning. The second quarter ended June 30, 2024. Valued funds from operation was 17.8 cents per unit compared to 17.5 cents in the prior quarter. Net operating income and NOI margin were $6.4 million and 52.6% respectively. This compares to $6.1 million and 50.8% in Q2 2023. For Q2 2024, operating revenue and operating expenses excluding the impact of IFRIC 21 were $12.1 million and $5.7 million respectively. On a comparative property basis, NOI increased by 6.8% year-over-year, bringing year-to-date comparative growth to 5.1%. For the quarter, general and administrative expenses were $1.1 million, which includes a one-time annual expense of $112,000 related to deferred compensation for board trustees. Interest and other income totaled $64,000. Net total debt to net total assets was 32.8% as of June 30, 2024. All of our debt remains fixed rate. Liquidity at the end of the quarter was approximately $77 million, comprising approximately $7 million of cash on hand and full availability of our credit facility. IFRS NAV at June 30, 2024 was $13.47 per unit compared to $13.52 at March 31, 2024. The IFRS values of our properties was $396.8 million compared to $398.1 million at the end of Q1, 2024. Overall, cap rates were largely flat at 5.75%. For 2024, we are maintaining our comparative property NOI guidance of 3% to 5%. We continue to expect 2024 FFO per unit to be in a low $0.70 range, excluding any acquisitions and our current total unit count. Thank you, and I will now turn it back to Brian.

Thank you, Derek. We'd be happy now to open up the call to questions.

We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. The first question today comes from Jonathan Kelcher with TD Callen. Please go ahead.

Thanks. Good morning. You guys, in terms of rent growth and trade-outs, you guys seem to have outperformed your peers. Do you think that's a function of your more affordable portfolio, and how do you expect that to trend as a New supply comes off, and the markets start to improve.

Good morning, Jonathan. This is Scott. The answer is yes. I mean, our communities are in the middle of the middle. We've spoken about that before. We're excited to see demand remaining high. We believe that our circumstances in Dallas are favorable. Even under challenging supply conditions, the demand remains strong. And then, of course, in Cincinnati, we're seeing consistent, strong rent growth, not only the past quarter, not only the past year, but really during our entire period of ownership. So we're very excited to see those trends continue. The value-add program certainly contributes to that, and there's demand there for that. And I would just characterize that middle of the middle and our ability to cater to a large swath of the American public who needs good housing. Okay.

And then on, Derek, you said you're maintaining the same property NOI at 3% to 5%, and you guys were just under 7% in Q2. Were there any one-time things in Q2 on maybe the operating expense side that you don't expect to flow through to the balance of the year?

Hi, Jonathan. No, there's a fairly absent of non-recurring or one-time items. So, I'd say no, it doesn't have any.

Okay. So, you'd expect to be closer to the top end of that 3% to 5% target than this year?

I think, Jonathan, one thing that we're just being mindful of in the short term over the next two to three quarters is rent growth is generally still indicative of the supply conditions. So, we're not going to, you know, we're not going to paint a rosy picture when we don't know how that supply is going to moderate off. But we're very excited about our stabilized operations. We're continuing to push rents through the summer, and we'll prepare to stabilize more as we enter the winter leasing season.

Okay. But are you confident you can sort of keep the blended around 2%? The blended tradeouts? Is that what you're referring to?

Yeah, the blended tradeouts, sorry. Okay. All indications would point to that at a minimum. Okay, thanks. I'll turn it back.

The next question comes from Brad Sturgis with Raymond James. Please go ahead.

Hey, good morning. I want to get a sense of, I mean, we've seen some larger portfolios starting to trade in the in the U.S. multifamily space with another one being announced yesterday. I guess from your perspective, you talked about maybe pursuing acquisition or growth through a JV strategy. I'd be curious to get an update of where things stand today on what you're seeing in the acquisition pipeline.

You bet, Brad. Let me start and I'll let Scott elaborate. We're seeing more capital coming into the multifamily space. We've seen a number of large transactions, the latest of which was yesterday, but a number before that. And I mentioned in my prepared remarks that we're starting to see, although we've had fewer transactions, we're seeing more capital starting to come into multifamily. as people look beyond the current supply surge and looking for renter demographics that are increasing kind of overall fundamentals, improving interest rates, reducing all of the kind of the stars are starting to line up for more capital investment in multifamily. We are looking hard at acquisitions right now. I mentioned that we want to keep a pretty flexible balance sheet because we want to, one, keep our properties attractive and relevant physically, like have made improvements in and have them up to date. But we also want to have capital available for acquisitions and kind of key strategic moves as we see opportunities. So we see that coming more and more as leverage comes down and as kind of property performance looks in the future to be pretty positive. Scott, you can elaborate what we're seeing on the ground in specific markets.

Sure, Brad. Good morning. I think right now we're seeing, you know, transaction volume is still relatively low comparatively over the past decade. And in terms of marketed opportunities, that number is still relatively low in each of our markets. What we are spending a fair amount of time on is conversations directly with owners, as well as with brokers about unmarketed opportunities. And we're seeing more of those kinds of conversations develop. And I think there's probably that bid-ask spread that's been very challenging over the past several years is probably tightening up a little bit. So we're seeing we're on the cusp of what may be a more liquid environment.

And would there be a willingness to trade assets, you know, out of the existing portfolio to help fund growth, or is it more a view of using the current capacity on the balance sheet while trying to maintain flexibility to be in growth mode at this point?

Yeah, we'd look at both. We'd look at both. We sold the property last year. We would look at potentially recycling some assets, but we could also use our balance sheet. So it would be a combination of all of those.

And, like, when you say the bid-out spread is starting to narrow, is that the vendor expectations are starting to come to where the buyers are? Or do you have to revisit your expectations on where valuations might stabilize from the buy side as well, given, you know, I guess a pretty volatile but sort of easing interest rate environment that seems to be appearing for the back half of the year?

I would say the sell side is probably – moving a little bit closer to where things ought to be right now. Okay. Sounds good. I'll turn it back.

The next question comes from Sairam Srinivas with Karamak Security. Please go ahead.

Thank you, Apoorva. Good morning, guys. Just looking back at the discussion on the supply pipeline and the leasing spreads, Have you seen supply essentially peak in some of your markets right now? And what's your outlook for the next maybe 12 months in terms of that supply headwind being there in the market? And what does that mean for spreads? Are you seeing that slowly taper down and recover right now? Any comments on that?

Good morning, Sai. Thank you for your call. So let's just start with I'll address each of our three markets. But broadly speaking, in our markets, we have seen supply peak in Q4 last year, perhaps in the Q1 this year. By example, last year, late last year, Dallas was about 7 percent of inventory was being, you know, delivered. And now it's down to about 4, 4.5 percent in the metro area in Dallas. Cincinnati, likewise, is reduced from high threes, maybe low fours at its peak, to down into the low threes now. And then Oklahoma City is also lowered down in the mid twos, I guess I'd say, is a percent of inventory. Nationally, we're still at 3.94% being delivered, which is about a percentage point higher than it might be in a stabilized world. And I think in 2024, supply broadly is peaking still ahead. In some of our target markets, that supply peak is still ahead. But in general, over the next 18 to 24 months, we're going to see that supply diminish and demand, you know, demand will overtake that in terms of absorption.

That's a great comment. Thanks, Brian. Maybe just looking at, you know, the new supply, obviously you guys are not directly competing with new supply in terms of product as such, but are you seeing a lot of the other, you know, what would have formerly been on the higher end of the product come down in terms of pricing, in terms of, you know, incentives, et cetera?

Absolutely. Absolutely we have. And I'll just give you an example. Luxury or high-end products, class A plus assets have taken a 15% price cut, nationally speaking, from their peak pricing about two years ago. So that compresses the whole space, especially in the A and the, you know, in the A space. And, you know, we feel that a little bit in our value add program, but we're still seeing demand. And we believe that we're sort of at a point where the future is getting better than today, and the renter demand is going to reflect that. So I think it's fair to say most analysts of the sector would agree that we're going to stabilize and improve in the quarters ahead.

That's actually a good comment. Thanks. Maybe just looking at the repositioning program, unless I read this incorrectly, I guess the first half units that have been repositioned mainly are in Dallas and Oklahoma, right, and not Cincinnati?

That's correct. We have, as we mentioned in Q1 and Q2, we've opened up Cincinnati as a redevelopment market, but we're doing fewer units in Cincinnati at just one asset as we get started there in that region.

Has there been any assets that have been completed in Cincinnati, and how is the return looking on those assets over there?

Yes, we have completed suites in Cincinnati, and I would characterize them as probably being the strongest returns across all three markets right now.

Awesome. Thanks, guys. I'll turn it back.

The next question comes from Jimmy Shen with RBC Capital Markets. Please go ahead.

Thanks. Just to follow up on the acquisitions, the conversations that you are having on market opportunities, can you comment on the cap rates that you're seeing? And I recall you used to target sort of high six, seven. I'm wondering, given... the rate environment where it is today, whether that's still the hurdle rate for you.

On a stabilized basis, Jimmy, yes, we're still going to target the high six, low sevens once we've stabilized the asset. We're seeing quite a variety of cap rates, and I think what you see in the market in terms of institutional trades is – in the lower five caps for very high quality stuff in coastal markets and whatnot and up from there.

And the vendors are asking in the high fives, in the assets that you're looking at?

I wouldn't narrow it that far. I would say it's more widely dispersed based upon product type and market and sub-market. Okay. I guess I'm just trying to... I would just add the transaction activity remains so low that narrowing down a value or a cap rate on a broad basis is challenging. Narrowing it down for a very specific asset in a specific sub-market is where we're focusing.

Yeah, Jimmy. This is Brian. To add to Scott's comments, there's opportunities where you've got significant mark-to-market management problems, things that may cause a property to not perform the way it should. So cap rates are not uniform, and I think Scott's giving you a good indication of where trends are and where they are overall, but it can vary quite a lot property to property.

That's fair. I guess what I'm really trying to ask is sort of like what would it take for you to take a little bit more of an aggressive stance, let's say, in terms of your acquisition strategy, especially you talked about You know, you've seen capital coming with the prospect of a better picture next year. Sort of what would it take for you to, for us to see some acquisitions from you guys?

Yeah, I mean, we're looking at total returns. We're looking at not only the going-in cap rate, but can we enhance value and can we kind of produce outsized total returns based on our kind of asset management of the asset, our aggressive ability to manage properties and to create value. So we're looking at unlocking value. We're not looking at just buying a coupon, and that's what would be really attractive to us. Okay. Thank you.

The next question comes from Kyle Stanley with Desjardins. Please go ahead.

Thanks. Morning, guys. Just sticking with the transaction environment right now, would you say kind of buyer demand in the market today is maybe a little bit more focused on value add or would that focus be shifted towards new build product just given all the supply? So I guess kind of the reasoning for the question is, you know, would you expect to see maybe a bit more of a retooling of existing more value add portfolios and that could eventually provide, you know, more value add product like what you're currently doing? invested in going forward?

Yeah, let me start, and again, I'll let Scott elaborate, but I think the big transactions that we've seen have been in stable, coastal, very liquid markets that Scott mentioned. So there's been demand there on large portfolio transactions, but the ice is starting to thaw across all of the transaction environment, and it's been very frozen. Like, we've seen very few transactions, but I mentioned, I think, early this in the call that we're seeing more capital investment coming into multifamily, and we believe that is kind of trickling through all the different kind of niches within the multifamily market. But, Scott, I think we're seeing more transactions. We're seeing more interest in value-add properties, both from a seller and a buyer, and I think some of the debt markets is helping drive some of that interest. I don't have anything to add.

That's good. Okay. No, I think that's helpful. And that's it for me. I'll turn it back. Thanks, guys. Thanks, Gal.

Once again, if you have a question, please press star then 1 to join the question queue. This concludes the question and answer session. I would like to turn the conference back over to Mr. Pauls for any closing remarks.

We'd like to thank everyone for joining us today for our conference call. We look forward to speaking again soon. Take care.