CA - Killam Apartment: Quality REIT Trading At A Slight Discount

2023-07-07 19:15:06 ET

Summary

• Killam Apartment REIT has managed risk well with laddered debt maturities.
• Net operating income growth has been more than sufficient to power funds from operations higher despite interest rate headwinds.
• We give you our buy point for this apartment REIT yielding 4.1%.

All values are in CAD unless noted otherwise.

As at March 31, 2023, Killam Apartment REIT (OTC: KMMPF , TSX: KMP.UN:CA ) had a portfolio valued at $4.9 billion and comprised apartment buildings, manufactured home sites or MHCs, and commercial properties. Although the investment properties are located across seven Canadian provinces, the majority of them are in the Atlantic Canada.

Also, as reflected in the above graphic, the 19,484 apartments do almost all of the heavy lifting in terms of contribution to the net operating income or NOI. While the 230 apartment properties are in all of the seven provinces, the 40 MHC locations and the real estate investment trust, or REIT's, 14 commercial properties reside only in the Atlantic region and Ontario.

Occupancy and Rent

Residential REITs are enjoying the higher demands bought on by the tailwind of housing unaffordability due to interest rate hikes. That, along with record-breaking immigration numbers, has driven the demand for residential rentals across the board. Unsurprisingly, Killam needed lower incentives to entice renters. The REIT expects the incentives to trend even lower than the Q1 number of 0.5% (of rental revenue), for the rest of the year. Overall, the occupancy levels were higher year-over-year.

Five of the seven provinces that the REIT has a presence in are subject to rent control. This would be around 57% of its portfolio as noted in the Q1-2023 MD&A .

In New Brunswick, the rental control is only applicable to MHCs. Nova Scotia has increased this limit to 5.0% on apartment lease renewals for 2024 and 2025, along with an increase to 5.8% on 2024 MHC lease renewals. Despite the controls in place, the tight rental market helped Killam achieve a 5% increase in total average rent and a 4% increase in the same property average rent on a year-over-year basis.

The noteworthy decline in BC was caused by Q2-2022 acquisitions, that are absent in the same property numbers of 2023.

Q1 2023 Operating Results

Year-over-year higher occupancy and rents trickled down to revenue numbers. Killam had a 9.6% increase in revenue, and a 12.3% increase in total net operating income or NOI to show for it, that despite a 5.8% increase in operating expenses.

Most of NOI was driven by the apartment portfolio, with it contributing over 90% of the NOI as we saw earlier in this article. The MHC portfolio had a 2.4% decline as operating expenses increased more than the revenue. Its commercial properties, comprised of retail and office buildings, had higher occupancy and rents compared to the Q1-2022 and showed a 16.4% increase in year-over-year NOI as a result of it. The funds from operations, or FFO, number beat the prior year, however, it was slightly muted in relation to the NOI due to the 27.1% in higher interest expenses compared to Q1 2022.

The weighted average interest rate on mortgages at the end of Q1 2023 was 2.80% compared to 2.63% at March 31, 2022. This number has been rising slowly and was 2.74% at December 31, 2022.

Coming back to the FFO, the total 5.6% increase trickled down only partially on a per unit basis since Killam had comparatively higher units in 2023.

Debt and Liquidity

As of March 31, 2023, Killam had about $422 million in debt maturities over the next twelve months.

There is really no risk of mortgages not getting renewed as they come due since they are CMHC backed. Additionally, because almost all of their debt is mortgages (secured debt), the maximum they stand to lose would be the corresponding property if a specific mortgage is not renewed.

They will, however, have to pony up for more for interest since the rates are higher. With a 103 basis points difference between the maturing and expected interest rate, the interest expenses will go up by about $4 million annually.

In terms of liquidity, Killam had around $120 million accessible from its credit facilities and cash on hand. This along with around $70 million in unencumbered assets, the REIT will not face a crisis on this front.

Verdict

Powered by a strong NOI, Killam recognized fair value gains on its properties in Q1.

It currently trades at a discount to its own calculated NAV of around $20.

This REIT is in a rare camp where the analyst estimations of its NAV are higher than its own and range from $19.50 at the low end to over $22 on the high end. That gives a modicum of confidence that the theoretical floor is higher than where this stock currently trades, around $17.40. Of course, shares can trade well below NAV in times of distress and that is true for Killam as well. Currently, the discount is about in line with peers like Boardwalk REIT ( BEI.UN:CA ) and Canadian Apartment Properties REIT ( CAR.UN:CA ). On a cash flow multiple basis, Boardwalk is the most expensive out of the 3.

Yielding around 4.1%, and based on the fundamentals, both micro and macro, the stock is certainly on the attractive side of things. Killam Apartment REIT gets a 4 on our potential pain scale rating.

At present, we would look at $16.00 as a good buy point for Killam Apartment REIT stock. That would be about 14X forward FFO and provide a solid margin of safety for the highly uncertain interest rate environment.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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