European Residential Real Estate Investment Trust

Q3 2023 Earnings Conference Call

11/7/2023

spk12: hello everyone and welcome to the european residential real estate investment trust third quarter 2023 results conference call my name is emily and i'll be coordinating your call today after the presentation there will be the opportunity for any questions which you can ask by pressing start followed by the number one on your telephone keypad i'll now turn the call over to nicole dolan investor relations please go ahead thank you operator and good morning everyone
spk08: 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 eRES, which are subject to certain risks and uncertainties. We direct your attention to slide two and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Tenney, Chief Executive Officer.
spk03: Thanks, Nicole, and good morning, everyone. Joining me this morning is Jenny Chu, our Chief Financial Officer, and Karim Farouk, our Managing Director. Let's turn to slide four to get started. E-Res' operational performance was strong this quarter. Residential occupancy rose to 98.7% at period end. Structurally speaking, we are effectively at our lowest possible vacancy, with the majority of our vacant suites only offline temporarily for value-enhancing renovation. This reflects continued tightening of the rental market in the Netherlands, which is also having the effect of higher monthly rents. Our occupied AMR grew to 1,053 euro as of September 30th, 2023, which is up by 7.1% versus the prior year period. This resulted from market-driven uplifts on turnover, as well as our most recent indexation. which had a weighted average increase of 4% as compared to 3% in 2022. Slide five provides a brief business update for Q3. We're continuing work with CBRE on our previously announced strategic review, and that remains top priority for us as we seek the maximization of value for our unit holders. In the meantime, we're making progress on our suite-by-suite privatization program. Having sold three individual residences closed during this past quarter for aggregate sales price of €1 million, this represents a premium to IFRS fair value. The fair value of our total investments portfolio declined by 1.2% to €1.7 billion at quarter end, primarily due to persisting inflationary and interest rate pressures. as well as ongoing ambiguity around potential changes to Dutch rental regulations. This contributed to the decrease in our not-for-unit to €3.05 at period end. I will now turn things over to Jenny to go through our financial results in detail.
spk11: Thanks, Mark, and good morning, everyone. Slide 7 summarizes our quarterly performance As Mark mentioned, our residential occupancy is holding high at 98.7%, while our monthly rents grew by 7.1% since the comparative period. Our safe property NOI resultantly increased by 7.8% this past quarter as compared to Q3 of 2022, which also includes the impact of slightly lower property operating costs as a percentage of operating revenue. This reflects the abolishment of the landlord levy tax, partly offset by increased R&M costs. On the whole, compared to the prior year period, our same property NOI margin expanded by 110 basis points to 79.5%, although this does include service charge income expense, which has no impact on NOIs. Excluding service charges, our same property NOI margin increased from 84.2% to 84.5%. Incorporating the impact of rising interest rates and higher current income tax A quarterly diluted FFO per unit decreased by 4.5% versus the prior year period to 4.2 euro cents. However, it increased from 4.1 euro cents achieved in the second quarter of 2023. This reflects our ability to remain operationally tight, which offset higher interest costs incurred since our most recent mortgage financing got closed at the end of June. With diluted AFFO per unit likewise down compared to Q3 of 2022, Our AFFO payout ratio accordingly increased to 77.8% for the three months end of September 30th, 2023. Turning to slide nine, sorry, turning to slide eight, you'll see our financial results for the nine months ended September 30th, 2023. Total portfolio operating revenues and NOI increased by 7% and 8.2% respectively, primarily due to strong rent growth we've discussed. Combined with lower property operating costs driven by the abolishment of land levy tax, our NOI margin increased by 80 basis points to 78.4%. Diluted FFO and ASFO per unit were down by 4.7% and 2.6%, respectively, which again reflects the impact of higher current income tax and higher interest on a mortgage portfolio and credit facility. Our AFO payout ratio increased to 80.6% for the year to date, which is within our long-term target range of 80 to 90%. Slide 9 presents our financial position and liquidity. You can see that our adjusted debt-to-market value ratio increased to 57% at period end, primarily due to the decrease in fair value of our property portfolio. This metric remains below our cabinet threshold, and we will continue to actively monitor and manage our financial structure and leverage to ensure we remain compliant. We have available liquidity of €188 million at period end, comprised mainly of unused credit on our revolver and the €165 million through the pipeline agreement or alternative promissory note arrangements with cap rate. This ensures financial flexibility going forward, though our priority at present is the fortification of our balance sheet. Our debt service and interest covered ratios are 2.5 times and 3 times, respectively, which are down due to the higher interest costs we're absorbing, but again, still above prescribed minimums. Finally, slide 10 presents our staggered mortgage renewal profile. Following our most recent financing, which closed at the end of June, We have no mortgages maturing for the remainder of 2023 and only 9% of our portfolio maturing in 2024. Our latest financing provided a principal amount of $76.5 million at 4.66% interest, and yet our weighted average effective interest rate remains low at 2.07%. This reflects our mitigation of interest rate volatility risk through fixing interest payments on 100% of our mortgages. I will now turn things back over to Mark to wrap up.
spk09: Thanks, Jenny.
spk03: I'd like to remind everyone that our Dutch property portfolio is deeply diversified, as you can see displayed on slide 12. Two-thirds of our portfolio is currently liberalized and half of our suites are located in the highly populated Randstad region in the Netherlands. In addition, approximately one-third of our portfolio is comprised of single-family units otherwise known as Dutch row houses, which typically have higher margins. This allocation means our portfolio is providing a home to a very broad and diverse tenant base and will continue to prioritize our commitment to providing all of our residents with a safe and enjoyable living experience in the Netherlands. At the same time, we're working hard to determine the best way forward in seeking to maximize return for our unit holders. While that strategic review remains underway, we're continuing to execute on our core strategy, which is outlined on slide 13. A robust rent program, which is predicted on suite re-letting, has been tried and tested. Our consistently strong operational results are a testament to that. We are also now acting on the additional opportunity to privatize individual suites. where that proves to be the best option for value maximization. Although we're just starting to make progress on this initiative, its pipeline of possibility is significant. We'll continue to methodically evaluate each suite, each opportunity, case by case, to ensure we're leveraging all of the available avenues for value creation. That brings me to our investment highlights on slide 14. I'd like to take this opportunity to thank all unit holders for your support, patience, and engagement. We face unprecedented operating conditions in our short history, but we remain dedicated to our strategic, financial, and operational objectives, and our overarching responsibility to act in the best interests of our unit holders. And that's exactly what we'll continue to do. With that, I'd like to thank you for your time this morning, Now I'll be pleased to take any questions that you may have.
spk12: Thank you. As a reminder, if you would like to ask a question today, please do so now by pressing star followed by the number one on your telephone keypad. If you change your mind and would like to be removed from the queue, please press star and then two. When preparing to ask your question, please ensure that your device and your microphone are unmuted locally. Our first question comes from the line of Frederick Blondeau with Laurentian Bank Securities. Please go ahead, Frederic, your line is open.
spk07: Thank you, and good morning. Just two quick questions for me. First question, looking at the turnover year to date, I was wondering if you could give us a bit of colour on the trend so far in Q4, and I guess your expectations for the rest of the year, and also what would be the main drivers here at this stage?
spk03: The conditions, Fred, are exceptional. The operating performance of eREDS is unquestionably strong. There is very much a live housing crisis there. The trend is, as you've seen, the low turnover that will ultimately hold back to a certain extent the true value release. But we've got some very strong indexation increases coming up here too. which is encouraging. So from an operating point of view, we couldn't be more pleased with how eREDS is really doing. It's really a simple matter of the interest rate environment only.
spk07: Fair enough. Thank you. And then I guess along those lines, I mean, how should we view your maintenance capex for, I guess, for the rest of the year?
spk03: Using the run rate of last year is a reasonable assumption, although we are pulling back wherever we possibly can. We've actually taken a revised look at what we're going to do this year. But if you were going to model, I'd use last year as a good example. Again, there's low turnover here. So there's limitations, at least on what can actually be done. But using last year as a kind of a ceiling would be a good approach.
spk07: That's great. Thank you. That's it for me.
spk03: Thanks, Fred.
spk12: Our next question comes from the line of Jonathan Kelcher with TD Cohen. Jonathan, please go ahead. Your line is open.
spk01: Thanks. Good morning. First question, just on the operating front, a little surprise in the strength in the suite turnover on the regulated suites. I know that obviously a 0.3%, not a lot did turnover, but maybe, like I thought that was based on some sort of point system with a maximum rent, so maybe a little color on that.
spk05: Sure, Jonathan, this is correct. I'm going to answer that one. So what we're seeing is when we're able to do some renovation and get a few points in, we do it when the payback is good only. So what we're trying to do now to the question before is maintain that 20% lift by spending less capital. And so that's our approach. So we're looking to regulate and we're looking to liberalize and we're trying to get a little bit more out of all the units by being very, very cautious on payback analysis and we're finding some incremental gains.
spk01: Okay, so on the regulated, there's an opportunity on turnover to get the points up, but I guess not enough to push it over into liberalized. Is that kind of the way to think about it?
spk05: That's correct. So renovating a kitchen or one bathroom, doing a small reno, that gives you a little bit of uplift, gives you good payback, but doesn't convert the unit.
spk03: It's points enhancement versus getting to the liberalized market.
spk01: Okay, fair enough. Secondly, on the individual suites, I know it's early days on that, or individual suite sales, I guess it's early days on that, but how big a program do you think that can ramp up to? Like right now, it's pretty insignificant, but can that get to something?
spk03: Okay, well, I guess I will give some better clarity on what we're doing. We started off by looking at the units that are not wholly owned, the buildings that are not wholly owned. where the financing allows us to do something. We will be approaching existing residents to see if they're interested in buying their home. Again, you've got this tale of two real estate issues in the Netherlands. Home prices have actually held up quite well, and income value properties have not held up very well. So I think that people will embrace the opportunity to potentially buy their home, And so we're targeting for now just that bucket of buildings where we don't own every unit so that we're not disturbing the valuation of the wholly owned buildings for now. And it takes probably, call it 90 days from first contact to closing. So what you're really seeing dribble in here is the initial outreach, very, very small, but we do expect to see a bit of a slight uptick in that in Q4 and ultimately Q1 of next year. That's the approach for now. We're also, remember, we've been extremely conservative to try to weigh the highest and best use of each unit, whether it's best in the rental pool as a liberalized unit, or if it's best going into end-user hands in the regulated space.
spk01: Okay, that is good color. I'll turn it back. Thanks. Thanks.
spk12: Our next question comes from Kyle Stanley with Desjardins Capital Markets. Please go ahead, Kyle. Your line is open. Thanks.
spk02: Good morning, everyone. I mean, there's likely not much more of an answer you can provide to this, but I'll ask anyway. I'm just wondering, you know, are there any other thoughts on the strategic review, progress, potential timing, anything else you might be able to provide?
spk03: No, there's really nothing more to report on that front.
spk02: Fair enough. That's what I expected. We've talked about it a little bit, but I guess with the focus obviously on the strategic review and then privatization where possible, have you thought about adjusting your capital investment strategy? Does continuing to invest and convert units, does that make them more desirable from a privatization standpoint or maybe an entire portfolio transaction or how are you balancing that, I guess?
spk03: It's a case by case basis, but yes. Of course, this is no different than when you sell your home. You do the appropriate renovations to maximize value. But we're doing it on a case-by-case basis, Kyle. The real criteria that we're eyeballing, quite frankly, though, is premiums to NAF, which we have been able to achieve on our least desirable suite. So the three that were sold were highly capex, deferred, regulated units that required significant investment with limited rental upside, and we were able to achieve a significant premium to the valuation in the NAP. So that's extremely encouraging. What's discouraging is the pace of progress here. So we're trying to play out that thesis evaluation and getting, I'll say, far more educated on how to do this process, how to run it, and what's in the best interest of the resident holders in the end.
spk02: Very encouraging. Okay, fair enough. That's great, Collar.
spk03: Yeah, we're very, like I've always been very optimistic about the alternative value of privatization. It's just a very long process to go through to pull full valuation out.
spk02: Right. Okay. Thanks for that. And then just the last one, I think you did the last mortgage financing that you did back in June was call it in the 4.6, 4.7% range. How have maybe five and 10 year rates moved since then?
spk11: Hey Kyle, it's Jenny here. I would say today's rate, it would be somewhere high four, low five. That's probably where the rates are right now.
spk02: Okay, great. That's it for me. I'll turn it back. Thanks.
spk12: Our next question comes from Himanshu Gupta with Scotiabank. Please go ahead. Your line is open.
spk00: Thank you and good morning. So just on the CBRE sale process, so Mark, Is the mandate to sell the entire portfolio at one go or are you considering selling parts of the portfolio as well?
spk03: No, all options are on the table. The strategic review was to find out and discover best value maximizing approach given the current environment. And really, that's all I can really say at this point.
spk00: Fair enough. And maybe how far along are you in that process? I mean, it's early days or are you getting to a decision-making stage now?
spk03: Well, I think we're several months in now since the announcement. It's obviously a big portfolio with wide coverage around the Netherlands. The process Again, it's being extremely thoughtful in terms of managing even communication. So I would say we are at the stage of the process that we expect it to be at this point in time.
spk00: OK. OK. Fair enough. And then maybe in terms of the suite by suite privatization process, I think you mentioned pace of progress is a bit discouraging there. Do you still have a target of how many units you can sell by the year end? I think last time you mentioned something like 100 units you can sell by the year end.
spk03: Yeah, again, we are evolving our approach. We started with such a conservative decision tree as to not disturb the value of the portfolio. Since the last call, we've taken a broader look at the units that already have individual units sold in them, so properties that we don't own 100% of the units in. And what we've tweaked now is an outreach to selective residents within that subgroup of buildings. And that is a different approach. That goes beyond vacant possession. That goes to connecting with existing residents that are interested in buying their home. And so, again, early days, we're not terribly at a point right now, a terrible experience, at least I would say, to give a run rate because we're in ramping up phase. But we've changed our approach slightly since the last call, and I'm hopeful to announce more unit sales at a premium to now. Again, the numbers are so small right now. It would be
spk00: misleading to try to give additional color on that okay and uh just the last question in terms of fair value adjustments uh i mean this quarter it has come down uh you know number the adjustment you have taken compared to the last few quarters so are you done in terms of making the fair value adjustments almost on this portfolio well we rely very much
spk03: on third-party appraisal to guide us in that process. Management doesn't like to interject too much discretion outside the appraisal process. The appraisal process, I think, yields the results it has. No different than other places in the world. Everybody is looking at the forward yield curve in terms of cost of funds. That appears to be glimmering some hope in terms of where rates are going, and it's a wait and see now. But there have been a few transactions in the Netherlands, very difficult to benchmark against our portfolio, but we're seeing some transactions bleed through now, and those deals would have been done at the height of interest rate tightening. So I think we're getting on the other side of at least the interest rate environment, and that should stabilize value.
spk00: Got it. Very helpful. I'll turn it back. Thank you, Mark.
spk09: The next question comes from Jimmy Shan with RBC.
spk12: Jimmy, please go ahead. Your line is now open.
spk04: Thanks. So just on the 60% debt-to-market value of assets covenant, I guess two questions there. One, I assume that's related to the credit facility, and two, how comfortable are you in maintaining that covenant given you are at 57% and market value remains within the range? So give us your thoughts about that.
spk11: Hi, Jimmy. It is. The first part is it is on our revolver. We're getting close, so obviously we're very actively in monitoring where we go, but even though you'll see those quarter cap rates went up by about six beats, but the net impact is fairly mild just given how strong our NOI growth has been and continue to be. The other thing that Mark mentioned is even though we have pressures on Fair Valley because of all the interest rate hikes, single unit home prices are really keeping up in Netherlands and we're continuing to see that, which also helps sort of soften that decrease. So I wish I have a crystal ball to say where fair values are going to be in the future, but do we see a very immediate risk to the covenant? No. Can I predict where our values will be in three, five years time also?
spk03: I was just going to say it's encouraging the way the appraisals work in the Netherlands is that they will take some degree of consideration for the privatization of vacant possession units only, not selling to residents, but vacant possession. And it's not specific to the property. It's sort of a generalized number. What's encouraging on it is the initial test of home sales in, again, least desirable homes is producing quite a significant premium to those valuations that already incorporate some privatization value. So if the program, proves to be successful, although we're going into a bad sell season right now in terms of Christmas and that kind of thing. But if the program is successful, eRIS will continue to pay down that revolver debt. And as Jenny said, the income results are incredible. So you've got this, like, again, dueling factors. You've got businesses doing great, but you've got less interest in income property right now because of where rates are. And you've got valuation of individual homes surging, but that's not a big part of the program right now. So there's extreme good news and there's headwinds in the results in terms of what's happening on the valuation front, but operating results are fantastic. We're very, very pleased.
spk04: Yeah, so on the revolver covenants and the interest coverage ratio, you're probably more than fine. There's definitely room for error there. I guess here it's just fairly close, right? Have you had any kind of discussions with the lender or any sort of contingency plan that you may be thinking about, or is it too early to be thinking about that?
spk03: Yeah, Jenny's in constant discussions with the lenders. All I can really say is, We are not alone in the environment there, and lenders fully appreciate the environment that we're in. I can't speak on behalf of the lenders, but we're in discussions there. Again, very grateful for the fact that our operating results continue to produce the way they're producing to keep things afloat.
spk11: And Jimmy, as we're continuing to privatize, a big portion of those proceeds are being used to repay the revolver and will help to leverage where we are.
spk04: Yeah, that makes sense. The three assets that were sold, were they single-family home sale? Yes, they were. Or Dutch row houses? Yeah, they were, okay. Yeah, so the townhouses.
spk03: No, we're doing obviously a strategic review. We're really priming the pump here for a program, but obviously in the context of the strategic review, we're also being very cautious on our privatization program. but we are definitely learning where the opportunities are in the portfolio. And the Dutch row house component of this portfolio is another characteristic that's probably not fully appreciated. These are very, very saleable and highly desirable. And we've built a portfolio with a large component of those Dutch row houses, which should give investors a lot of confidence
spk12: Our next question comes from the line of Stephen Sadler, who is a private investor. Stephen, please go ahead. Your line is open.
spk06: Good morning. I'd like to congratulate you on your operating performance. I think it was quite exceptional. In the next two years, you have about $300 million worth of debt maturing at very low rates, under 2%. which would, if rates don't go down and stay the same, would imply an increase in interest expense of somewhere around $8 or $9 million. Do you think you have enough growth in your revenue and the way you're handling everything to compensate for that or a part of that?
spk03: Well, where we keep going to is the exceptional operating results are definitely mitigating interest rate impact so we do have a quite a attractive debt pool and where rates go and our ability to privatize or sell assets to pay down maturing debt will have a huge influence over your question okay so we do have a Very good confidence now in the single-family home sale market. That's encouraging. There's a housing crisis in the Netherlands. We have liquidity on that front. Unlike our North American apartment peers, we have alternative liquidity outside of selling income assets. We have this individual home attribute. So I have a good comfort. There's two fundamental things going really well. A, the results are great. The operating margins are hitting really incredible levels thanks to the hard work of the team. And there's a housing crisis going on, and they're just not building homes in the Netherlands. So that just keeps the embedded value in our portfolio going up. So these are the two things that are really working in our favor. When are rates going to go down? You know, we're all watching that carefully. I don't think anybody has a clear answer. And where will liquidity come from? The team has good confidence here that we have liquidity in the portfolio. To deal with debt that might become too much for the debt service.
spk06: I'm sorry, could you say that again? You were breaking up a bit.
spk03: No, I'm just saying... We have good liquidity options. In the event that debt becomes too expensive and we see a further erosion, we have other options to deal with that debt.
spk06: Okay, thank you.
spk09: You're welcome.
spk12: Those are all the questions we have, so I'll turn the call back to the management team for any closing remarks.
spk03: Well, thank you, everybody, for your time today, and we appreciate your ongoing interest in U.S. If you have any further questions, please do not hesitate to contact any of us at any time. Thank you again, and have a great day.
spk12: Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

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