Killam Properties Inc (OTC:KMPPF) Q3 2019 Earnings Conference Call November 6, 2019 12:00 PM ET
Philip Fraser – President and Chief Executive Officer
Robert Richardson – Executive Vice President
Dale Noseworthy – Chief Financial Officer
Erin Cleveland – Vice President of Finance
Nancy Alexander – Senior Director, Investor Relations
Conference Call Participants
Jonathan Kelcher – TD Securities
Johann Rodrigues – Raymond James
Matt Kormack – National Bank Financial
Kyle Stanley – Desjardins Capital Markets
Brad Sturges – IA
Troy MacLean – BMO Capital Markets
Good afternoon. My name is Lindsay, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Killam Apartment REIT’s Third Quarter 2019 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
Mr. Philip Fraser, President and CEO, you may begin your conference.
Thank you. Hello, and thank you for joining Killam Apartment REIT’s Q3 2019 Conference Call. I’m here today with Robert Richardson, Executive Vice President; Dale Noseworthy, Chief Financial Officer; Erin Cleveland, Vice President of Finance; and Nancy Alexander, Senior Director of Investor Relations.
Slides to accompany today’s call are available on the Investor Relations section of our website under Events and Presentations.
I will now ask Nancy to read our cautionary statement.
Thanks, Phil. This presentation contains forward-looking statements with respect to Killam Apartment REIT’s operations, strategies, financial performance and conditions. The actual results and performance of Killam Apartment REIT could differ materially from those expressed or implied in such statements. These statements are qualified in their entirety by the inherent risks and uncertainties surrounding future expectations.
Important factors that could cause actual results to differ materially from those expressed include, among other things, general economic and market factors, competition, changes in government regulations and factors described in the Risk Factors section of Killam’s annual information form and other securities and regulatory filings. This cautionary statement qualifies all forward-looking statements attributable to Killam and the persons acting on its behalf. Unless otherwise stated, all forward-looking statements are as of the date of this presentation, and the parties have no obligation to update such statements.
Thank you, Nancy. I’m pleased to report another very strong quarter for Killam. We achieved net income of $46.8 million compared to $27.1 million in Q3 2018 and earned funds from operations of $0.27 per unit, a 3.8% increase from Q3 in 2018. We’re focused on our strategic priorities and continue to execute on our targets for the year as summarized on Slide 4. Performance from our same-property assets has been strong, and we’re on track to meet our same-property
NOI growth target. We’ve completed a $149 million of acquisitions so far this year, growing the portfolio to $3.1 billion. We will meet our 2019 target to earn at least 30% of our 2019 NOI from outside Atlantic Canada.
Our development plans are on track, including The Kay in Mississauga, which is now officially underway. And we’re maintaining a strong balance sheet with conservative debt metrics. On Monday, we completed a $100 million equity raise. This raise sets us up for continued growth in the year ahead. Approximately half of the funds raised have already been applied to our line of credit and the remainder is expected to be used to fund acquisitions and developments. Following the close of this equity raise, our debt levels have improved by approximately 110 basis points down to 46% and our acquisition capacity has increased to approximately $300 million.
I will now ask Dale to recap our financial results.
Thanks, Phil. Slide 5 highlights our Q3 and year-to-date financial results. Killam generated FFO per unit of $0.27, 3.8% higher than Q3 2018. Year-to-date, we generated $0.73 in FFO per unit, up 2.8% from last year. This growth is attributable to accretive acquisitions and developments and solid performance from our existing portfolio. Same-property revenue and NOI growth were both strong in the quarter.
The trend of high occupancy and rental rate growth continues, as illustrated on Slide 6. Rents were up 3.4% in Q3, 90 basis points ahead of a year ago and our highest average rental rate increase in 7 years. Strong fundamentals paired with our revenue-enhancing programs are driving higher rents, improved occupancy and low incentive offerings. We remain focused on expense management.
As shown on Slide 7, same-property operating expenses were up 2.1% in Q3. Energy consumption savings, realized from LED lighting retrofits and other efficiency investments were partially offset by higher water and natural gas rates as well as inflationary increases and timing differences in general operating expenses. Property taxes were also up, increasing 2.5% quarter-over-quarter due to rising property assessments. In total, Killam’s same-property NOI margin increased by a healthy 60 basis points in the quarter and 40 basis points year-to-date.
We continue to manage our balance sheet conservatively, as highlighted on Slide 8. Debt as a percentage of total assets was 47.2% at the end of the quarter. Following the close of the recent equity raise and the subsequent repayment of the balance outstanding on our line of credit, our debt metrics have improved, which are expected to be seen with our Q4 results. In addition to a stronger balance sheet, Killam’s acquisition capacity has increased substantially.
Slide 9 highlights our debt maturity profile, including average apartment mortgage rates by year versus CMHC-insured rates. Based on current market conditions, we expect to refinance maturing debt throughout the remainder of this year and over the next 3 years at relatively flat rates.
As shown on Slide 10, Killam’s real estate portfolio has grown to $3.1 billion in value. We’re acquiring and developing new high-quality assets in prime locations and investing in value-enhancing capital upgrades at our existing assets. Same-property NOI growth has contributed to fair value gains across the portfolio. In addition, we’ve continued to see cap rate compression this year, including a 16 basis point tightening in our apartment portfolio and a 113 point compression in the MHC portfolio. Year-to-date, we’ve recognized a $134 million in fair value gains, including $36 million in Q3.
A highlight this past quarter was cap rate compression in the Halifax market. We’ve seen an increase in the amount of demand for apartment product in Halifax from both local and institutional investors. CBRE highlighted this cap rate compression in its Q3 report. The second quarter in a row, they’ve highlighted valuation increases in the Halifax market. Investors are attracted to the city’s solid apartment fundamentals, including strong population growth, rising rents, and low vacancy.
I’ll now turn the call over to Robert, who will provide details on our operating performance this quarter.
Thank you, Dale. Good afternoon, everyone. As shown on Slide 11, Killam continues to execute its strategy of increasing unitholder value specifically, we continue to focus on increasing funds from operations and net asset value-based on 3 strategic priorities: one, increased Killam’s earnings from its existing portfolio; two, expand the portfolio, diversifying geographically through accretive acquisitions with an emphasis on newer properties; and three, since 2010, Killam has developed high-quality properties in Killam’s core markets.
I will focus on Killam’s operating performance year-to-date and detail a number of key revenue and expense management initiatives before turning the call back to Philip to discuss our year-to-date acquisitions and development progress. Killam’s existing portfolio of 16,000 apartment units, 5,400 MHC sites, plus 750,000 square feet of commercial space is focused on maximizing unitholder value. Our strong same-property NOI performance in 2018 and year-to-date 2019 is largely attributable to our ability to grow revenues.
Slide 12 charts the rental rate trends over the past 3 years. We’ve generated consistent revenue growth each quarter for the past 7 quarters as we execute Killam’s revenue-enhancing programs. For Q3 2019, we delivered overall same-property rental rate growth of 3.4%, a 90 basis point increase versus Q3 2018. Broken down, renewing tenants, which annually represents plus or minus 70% of our apartment portfolio delivered an average gain of 2.1%, up 40 basis points over Q3 2018. However, Killam’s best rental return is with units rented to new tenants on turnover. This quarter, Killam delivered 5.7% rental growth on new leasing, a 70 basis point improvement versus the same period in 2018.
Please refer to Slide 13. Killam’s value proposition and market conditions have never been stronger. As we experienced record occupancy levels in many of Killam’s core markets, we’ve seized the opportunity to optimize rents as units turned by executing on 2 key strategies: First, 78% of Killam’s apartment units are open market, meaning, Killam can bring rents to market at renewal time, instead of exclusively when a unit becomes vacant, as is the case in Ontario, for example; and secondly, this year, we will invest between $7 million and $8 million to renovate and upgrade select units to generate on-average an all-cash return of 13%.
Market demand for Killam’s new and newly renovated rental units is healthy across the portfolio and in response, Killam has accelerated its suite repositioning program. For 2019, we will deliver 300-plus repositioned units that should generate an aggregate $1 million in additional net operating income. With 250 suite renovations completed, we are executing to plan. So far in 2019, the average monthly rental increase for a repositioned unit was $280, generating an unlevered return of 13% on an average investment of $26,000. Given these metrics, Killam plans to increase its unit repositioning program to complete 400 to 500 units in 2020.
We expect this to improve our top-line annualized revenue by approximately $1.5 million. Units enhancing upgrades deliver outstanding returns, and this reality is not restricted to a specific geographies or properties, but it’s virtually universal across Killam’s portfolio when we upgrade any unit older than 10 years. Killam has identified approximately 3,000 additional units for repositioning. Once these are completed, we expect to earn an estimated $10 million in additional annualized rental revenue, representing an approximate $195 million increase in net asset value. The average cost to reposition a unit is approximately $25,000 or $75 million for these 3,000 units.
I also want to highlight that once these 3,000 units outlined here are completed, the cycle starts again on a portion of remaining 13,000 units in our portfolio that will by then have reached their 10-year threshold. The cycle is continuous.
As in past quarters, I will quickly profile 1 of Killam’s properties undergoing a renaissance. Please turn to Slide 14. Fort Howe and Saint John, New Brunswick has commanding views overlooking the Saint John Harbour was constructed 50 years ago and is still one of the largest apartment buildings in New Brunswick with 153 units. This mid-rise property is being upgraded with new cladding, a new heating system, and most importantly, newly renovated units. At Fort Howe, Killam, on average, invests $36,000 per unit to upgrade kitchens, bathrooms, and flooring and generates $390 or 41% more rent per month. Overall, a 13% all-cash return on investment.
In conjunction with driving revenue growth, Killam is actively managing expenses to optimize net operating income. Killam is executing its five year $25 million energy efficiency plan focused on energy savings such as installation of ultra-low flow toilets, LED lighting retrofits and heating system upgrades. These projects help to lessen Killam’s carbon footprint and mitigate the impact of expense increases from rising energy rates and other inflationary pressures. This year, we’re on target to complete $5 million in projects, having an average 5.6-year payback or an 18% return.
For the past four years, Killam has attracted its portfolio’s energy intensity on an expense per square foot basis, along with its carbon dioxide emissions. As Slide 15 details, we’re now tracking — sorry, taking monitoring further by working with a 3% — with a third-party supplier to complete a full baseline audit of our Greenhouse Gas emissions. Ensuring our metrics are consistent and benchmarked against the leading green multi-res companies in North America. We’re fully committed to being amongst the leaders in ESG for multi-residential REITs and working diligently to reduce our environmental footprint, ensure effective and ethical governance and invest to maintain sustainable economic growth.
Slide 16 profiles Killam’s strong same-property rental rate growth and NOI growth by region for Q3 2019. The importance of geographic diversification is evident in this slide as it highlights the NOI growth of not just Ontario at 7.8% this quarter, but also Halifax, all three New Brunswick Cities and Charlottetown. Our properties in Ottawa, London and Cambridge GTA maintains excellent occupancy in rental growth for both routine and repositioning units this quarter, delivering NOI growth of 9.9%,8.5% and 5.4%, respectively.
Once Killam’s leading marks for rental growth for many years, the new plan economy has been challenged for the past three. For Q3 this year, vacancy increased nominally to — by 20 basis points quarter-over-quarter. But average rents improved by 80 basis points, so there are signs of encouragement in the market. Saint John’s economy remains dependent on oil, so when the Atlantic Provinces Economic Council states Newfoundland’s GDP should grow 2.7% for 2019 and an additional 2.4% in 2020, bolstered by the ramp-up at Hibernia and Husky’s White Rose projects, we expect Saint John’s occupancy to improve noticeably next year.
In Alberta, Edmonton same-property results consists of two properties acquired in 2017, Waybury and Tisbury. These properties are taking longer to stabilize than expected. Their combined occupancy for third quarter 2019 was 85.4%. However, I’m pleased to report that their current occupancy in November is now 90%. As well, Killam’s 176 unit Vibe Lofts property also located in Edmonton, which is not part of the same-property numbers having been acquired midyear 2018, is 97% occupied, giving Killam a combined Edmonton occupancy of 93%. We’re optimistic this trend will continue into 2020. We’re pleased with our 531 unit Calgary portfolio this quarter. Same-property occupancy was up 60 basis points and average rental rates improved a healthy 3.9%. Calgary feels like it’s stabilizing with overall occupancy at 95% this quarter.
I will now hand you back to Philip to provide details on our acquisitions and new developments this quarter. Thank you.
Thank you, Robert. Slide 17 details our annual acquisition history and year-to-date activity. Killam has acquired a $145 million of assets in the first 9 months of 2019. We’ve exceeded our minimal acquisition target for the year and with the recently closed public equity offering, we will continue to look for accretive opportunities to add to our portfolio.
During Q3, Killam purchased a 48 unit property in Fredericton, New Brunswick, as shown on Slide 18. The purchase price of this 48 unit building was $9.25 million, with an all-cash yield of 5.4%. The building is currently a 100% occupied. Subsequent to the end of Q3, we purchased a 359 site, seasonal manufactured home community located in Shediac, which is located at just outside Moncton, New Brunswick for $3.8 million.
Since our development project program started 8 years ago, we have completed 11 development projects in 5 provinces, consisting of 1,200 units at a cost of about $300 million. And most recently completed development Frontier is shown on Slide 20 and 21. Co-development RioCan opened on June 1. Frontier was completed on budget and on-time and is currently 90% leased. We expect to be fully leased in the next 2 to 3 months. The all-cash yield on this development is approximately 5.25%, a healthy 125 basis points above current cap rates. This has resulted in a $9.7 million gain in fair value to date on our 50% interest.
Slide 22 shows rendering Frontier and Latitude. Although project development costs have increased per unit in the second phase, the expected rents have also increased due to strong market demand in the Frontier. The expected all-cash yield is still 5.2%. We broke ground in Q2 on the Latitude and progress photos of this 209 unit project are shown on Slides 23. The expected completion date is in late 2021. The progress photos of our Shorefront development located in Charlottetown, PEI, are shown on slides 24 and 25.
We’re pleased to have broken ground on The Kay in Mississauga. This 128 unit development, as shown on slides 26 and 27, has a $56 million budget with an anticipated all-cash yield of 5%, approximately 150 basis points higher than the current market cap rates. Construction will take 24 months and the expected completion date is in mid-2021.
Finally, we continue to refine and advance our development pipeline. A full list of our development pipeline is included on Slide 28. It’s worth noting that over 90% of Killam’s future development pipeline that is scheduled to be completed in the next 5 years is located in Ontario and Alberta.
To finish, Q3 has been a very good quarter with strong operating and financial performance. Our focused strategy is leading to increased earnings, a stronger balance sheet, more geographical diversification and one of the highest quality apartment portfolios in Canada.
This concludes the formal part of the presentation, and we’ll now open up the call for questions.
Thank you. Ladies and gentlemen we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Jonathan Kelcher at TD Securities. Please go ahead.
Thanks, good afternoon. First question, just on the repositioning program. What markets are you generally doing that in?
You know what? Actually, in most markets, because we’re doing it as the units come vacant. So we were not taking any properties offline, Jonathan. So it is broadly based through the portfolio.
Okay. And then if I look at your 2020 target and do a little bit of the math on Slide 13, it looks like the expected yield on your cost goes up a little bit from 2019. Is there anything to that or am I just being too fine what the details there?
We think it’s just a range. We’re going to be in the same range. I think last year, we would have reported, if I recollect properly, it’s 14%, this year is tracking at 13%, but I think we’re in the same range, more or less.
Okay. Because it’s always like sort of 16% to 19% for next year based on what you have there. And then just switching gears, the gap between renewals and turnover, is there — how much of a difference is there in that in the rent-controlled markets versus non-rent controlled markets?
Well, I don’t have the answer right off. I do know 1 of the markets has — it was 2.1%.
Yes. No, I can speak to the — Jonathan, it’s Nancy. I can speak to the turnover that most of — we have seen some tightening in our Ontario market on turnover. That’s mostly in our other open markets. Our number has pretty much stayed consistent. This whole two thirds every new and one thirdsturn. It has come slightly as it come down slightly as you’ve seen some more demand here. But I would say mostly, we’ve seen a lot of tightening in Ontario.
Okay. Actually, I was trying to get.
You’re asking about the rent increases?
Yes, the rent changes.
I mean, it’s certainly, they’ve been high in those markets, but they’re high in our other markets, too. So when you look at the weighting of our portfolio and to be at the kind of 5.5% range, we’re seeing it — we’re seeing those higher increases in Halifax and in New Brunswick and in Ontario. I’d say those are the areas, all of those. Ontario probably stands out a little bit higher than that, but those markets are all strong because offsetting that a bit is a bit more of the weakness that we would have talked about in Newfoundland and Alberta, too. So we’re seeing very healthy numbers in most of our markets.
Okay. And just following up on that, are you finding that you’re able to start to push on renewals in Halifax? Or do you just sort of keep them in the 2% range and get the gates on turnover?
I’d say that we’re — when you look at what — we provide those numbers to say, to get to 2%? Well, that’s a healthy increase from what we were seeing even just a year ago and certainly compared to two years ago. So we look at it market-by-market and building by building and where there’s opportunity, we look at that. But certainly, we’re getting more on the turns.
You mentioned the Halifax market in particular. So the average rent market is about $1,100 to $1,150. So getting 2% is $22 or so. So there’s the ability to probably move it a little higher in that market. Because those rents are so reasonable when we compare it to owning a house, but the value delivery on 2-bedrooms at $1,150, all you have to pay is electricity because we would cover the heat. That’s good value.
Your next question comes from Johann Rodrigues at Raymond James.
That’s close enough. I was just wondering, looking at the appendix, I don’t know, maybe it’s the scale of the graph. But it doesn’t seem like there’s a dramatic drop off in incentives in Halifax, New Brunswick, but it doesn’t seem like Ontario is dropping. Given how strong that market is, I don’t know, maybe if you could add some color on that?
Yes. So the rental incentives, I think, on that graph, the way it’s showing on Ontario, there has to do with a property that we have supplements for in that, in Toronto, in the GTA, our Ashington property. We have some rental supplements that we consider as incentives. So you’d see that’s pretty flat. So other than at that 1 specific property, their rental sensors are virtually — they’re minimal in Ontario as well. And those subs — that relates to a long-term agreement objective. So it’s…
Yes, so it’s more like a subsidy, not incentive?
It’s further contract on the property.
Okay. And then just in terms of acquisitions, focusing on outside of Atlantic Canada, are you guys looking at Québec or Montreal at all?
Our primary focus is in Ontario and out West.
[Operator Instructions] Your next question comes from Matt Kormack at National Bank Financial.
With regards to your suite repositioning program, just wondering how you think of building improvements more generally? And if you would do those in advance of the suite repositioning or if you reposition the suites and then look at common areas thereafter?
We would typically run those on their own programs. What we found is the exterior work certainly is revenue-enhancing, but most importantly to our tenants, when we survey them, it’s about their units. But we can get it and get the unit done, we can come back and finish the rest if that’s necessary. So there’s not really a requirement that you have, they have to be aligned. We don’t see a big lift there with our renovated unit in an older property, that unit on its own can command a fairly decent rental return.
Okay. And would you say, I mean, obviously, turnover governs your ability to renovate these but at this point, I would assume there’s money to be made on pretty much every suite that you own? Or are there still assets that you wouldn’t necessarily look at suites, obviously in the older product, not the newer product, but…
So in the older products. So the 11 new builds, you wouldn’t touch those for some year right now because they’re current. But the other properties, it’s interesting how much the appetite is in a marketplace, for renovated units. And it could be anywhere, in any market. If we renovate a unit, there’s a return to be had. And it’s typically double digits, and so we’re motivated to unturn units that we can get in there to do that.
And in terms of the spec that you’re putting in these, obviously, it’s probably more expensive to replace, but does it last longer than what you had previously in the units?
We haven’t had them all done long enough. I will say this about the flooring. So in some of the buildings, especially in the Ontario market, where they would’ve had hardwood flooring, that’s very durable. It lasts for a long time. These days, we’ve landed on a newer product for flooring that I think has a much longer life than we’ve seen with others. Carpets don’t last long as they used to, so and they’re not popular in any event. But really, this, the, it’s called luxury vinyl tile. And it is, it’s a very good product, durable, easy to install and not affected by water. So it’s a real, so that’ll last a long time.
Your next question comes from Kyle Stanley at Desjardins Capital Markets.
Just one quick question from me. Would you be able to disclose the NOI contribution from Frontier during the quarter?
That will be NOI, but I don’t want to give a lot of detail. So I would say that when you look at, I know the FFO contribution is pretty slim in the quarter when you look at the interest expense that we would have had and because of the lease-up, so it’s marginal. So certainly, I would say was positive from an FFO perspective, but we have not yet really seen the juice from that acquisition in this quarter. I’d say Q4 is when we’re really going to start to see that. And we would look at 2020, that’s when we’re going to see some real, the real benefit from that from an earnings perspective.
Your next question comes from Brad Sturges at IA.
In terms of the acquisition opportunity you see today. Obviously, your preference is the new builds. Are you seeing any portfolios or smaller portfolios that would be of interest today that you’re looking at or is it, if we’re thinking about acquisitions, it’s still more of the one-offs?
Brad, it’s Phil here. The acquisition environment, there’s still a lot of product. Everything is very competitive in terms of trying to buy it, but there’s a number of opportunities that are just consists of a single asset, whether they’re at west or in Ontario. But there is also probably known to every sort of multifamily REIT out there and pension fund that there’s 3 plus mid-sized portfolios in Ontario, and there’s 1 large portfolio for sale that’s currently here in Halifax. That’s attracting a lot of attention right across the board. Very big fit from our point of view, big purchase items. We’re looking at it, but it’s way too early to tell if we’re going to be the eventual winner on any of them.
Got it. And would those be more of a value creation opportunity or would they have a component of that, does have the new build that would kind of fit into some of the assets you have been buying recently?
Well, I mean, I can speak to the Halifax one, which is public information, it’s 7 or 8 buildings, 1,500 units with really just 1 new property, but most of the portfolio, not all of it is very well located, very well maintained. That’s just a good product, but the question is, it’s — we do have a loss here already.
Okay. Great. That’s a good color.
I think that the portfolios are older stock, first time coming available in many, many years.
Yes. You said, Ontario, correct?
And I guess whereabouts in Ontario are the portfolios, generally speaking, are there larger markets or smaller markets?
They’re all in been between Oshawa and Kitchener, Waterloo.
Okay, great. Thank you.
[Operator Instructions] Your next question comes from Troy MacLean at BMO Capital Markets. Please go ahead.
Just on Ottawa, it was very strong this quarter. Can you talk about some of the things that are driving that? And how much more room you think there is to push rents and occupancy in that market?
I think Ottawa, it’s a big urban center, and it’s in Ontario and really, it’s — a lot of it is driven by job creation and also the immigration increases in population. And those 2 things alone are driving the multifamily market.
Phil, before you mentioned your target markets for acquisitions, but are there any new markets you’re looking at entering? Montreal is a big one that a lot of people seem to try to get exposure to. Is that something that’s on your radar screen? And if you were to look at a new market, what kind of scale would you need kind of going in, would you need a big portfolio or do something through maybe on the development side?
Well, it’s the — I’ll try to answer all those questions that you posed right there. I mean, Montreal is a market that we’ve all obviously had looked at over many years, over the years as we’ve been in business. And right now, it’s a sought-after market for sure. The new markets that potentially might enter into for us would be sort of the western part of Canada. And obviously, we’re in the 2 cities in Alberta and the other market that eventually, we think, has great opportunities and also the future of it would be the southern part of DC, eventually.
And then how do you get into a new market, just like we’ve got into the markets in Alberta. It’s done by one asset at a time. Right now, we have a base in both of those cities. And it’s just basically getting one asset and then growing it from there. The opportunity to go in and get a mid-sized portfolio or a large portfolio in a new market. I think it’s very limited for us these days.
There are no further questions at this time. Please proceed.
I would like to thank everybody for participating and listening today, and we look forward to reporting our Q4 results in February of 2020. Thank you.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.