BOWFF - Minto Apartment: Attractively Priced Residential REIT

2023-08-29 09:25:19 ET

Summary

• Minto Apartment REIT has been one of the worst residential REIT performers amongst those that own Canadian apartments.
• We examine the risks from the debt load and compare vs. peers.
• We also take a look at the implied cap rate vs. the NAV cap rate and give you our verdict.

All values are in CAD unless noted otherwise.

We covered Killam Apartment REIT (KMMPF) in July of this year and came away with neutral sentiments on it. We liked the risk management and staggered debt maturities of this primarily apartment REIT. The record breaking immigration numbers in Canada turbo charged its net operating income or NOI, helping it even outpace the interest rate hikes plaguing the bottom line of a majority of companies at this time. Yielding around 4%, the REIT was selling at a slight discount to its net asset value or NAV. We wanted to buy it at 14X forward FFO, and since it was trading higher than that, we gave it a pass. Today, we will review another residential REIT to see if it passes muster, unlike Killam.

Minto Apartment Real Estate Investment Trust ( MI.UN:CA ) is a developer, owner and operator of multi-residential rental properties in Ottawa, Toronto, Montreal, Calgary and Edmonton. While the REIT co-owns a portion of its 31 property portfolio, majority of it is wholly owned by it.

Minto distributes $0.04083 monthly and, based on its current price of $13.21, yields its investors around 3.7%. Killam, on the other hand, yields slightly higher at 3.9%, but not by much. Both trade at a discount, but Minto is a black sheep, comparatively.

Minto fares similarly when compared to the two behemoths in this space, Boardwalk Real Estate Investment Trust ( BOWFF ) ( BEI.UN:CA ) and Canadian Apartment Properties Real Estate Investment Trust ( CDPYF ) ( CAR.UN:CA ).

Another metric that reflects market's disdain for it is the total return on price over the last three years, compared to the aforementioned competitors.

We would be remiss if moved on with this piece without giving a virtual high five to the Boardwalk unitholders. The stock is overvalued in our opinion, but that has not stopped the monster move. Coming back to Minto, the price decline more than offset the glee its investors got with their dividends over the last three years. With the immigration boom, why is Minto doing so much worse than its counterparts? Let's see if the answers lie in the recent financial results.

Q2-2023

Accretive acquisitions, an increase in average monthly rents, a lower turnover, and a rise in occupancy levels, all had a hand to play in the 11% year over year revenue growth for this REIT and its co-owners.

Lower inflationary pressures aided the growth in revenue to more than offset the increase in year over year operating expenses. A special shoutout goes to the renegade among the property level expenses, natural gas. A double-digit drop in natural gas rates, combined with a warmer 2023, resulted in a healthy 16% decline in that expense.

The overall result was a 12.5% higher net operating income or NOI compared to Q2-2022. The 42% increase in interest costs was the main culprit in the 12.8% decline in year-over-year funds from operations or FFO. However, more than half of that increase was from non-recurring items.

Therein lies the difference between the change in the plain ole FFO and the normalized FFO, which was slightly positive. Both of these are shown in the first graphic of this results section. Minto is working hard to reduce its variable rate exposure, and debt retirement costs are part of that deal.

Minto addressed the magnitude and the impact of these refinancings in their press release .

During the quarter we refinanced seven mortgages with long-term CMHC-insured fixed-rate mortgages which reduced our variable-rate debt exposure from 26% of Total Debt to 11%, a reduction of over $165 million. This also generated over $70 million of incremental proceeds we used to pay down our revolving credit facility ("Revolver") which is immediately accretive to FFO per unit. These initiatives only partially impacted Q2 2023 results, with the full increase to be realized in Q3 2023 and beyond.

The debt service coverage ratio declined from 1.66x at the end of 2022 to 1.48x at the end of Q2-2023 due to additional borrowings on its credit facility and higher rates on the facility and the REIT's variable rate debt. Overall, while the rates it got on its Q2 refinancings were higher than its weighted average of 3.21%, the REIT took the right steps in light of the rates it was paying.

In April and June 2023, the REIT refinanced two variable rate mortgages totaling $108.4 million with interest rates of 7.44% and 7.70% and secured $113.4 million of CMHC-insured fixed-rate mortgages with interest rates between 3.85% and 3.87% that mature in 2033. In May 2023, the REIT refinanced five maturing mortgages totaling $137.4 million with interest rates between 2.98% and 5.34% with $218.6 million of new CMHC-insured fixed-rate mortgages with interest rates between 3.90% and 4.00% ³ that mature in 2028 and 2033.

Source: Press Release

With CMHC's blessings, Minto, like it brethren, enjoys lower than prevailing rates, but it still feels the impact of hikes with every refinancing.

The weighted average interest rate on term debt increased from 3.06% at December 31 to 3.21% at the end of Q2. We like the 5.87 years of weighted average term to maturity of this REIT. In comparison, CDPYF has a 5.1-year average term to maturity, albeit with a lower weighted average interest rate.

Boardwalk, the superstar, comes in far lower at 3.6 years of average term to maturity.

At 3.8 years , Killam is closer to Boardwalk, than to CDPYF and our protagonist. So compared to his peers, Minto comes out ahead in this regard.

Minto had around $163.3 million in liquidity at the end of Q2 and was focused on increasing its cash flow per unit. It took some prudent capital decisions in light of that last quarter, deferring its planned intensification project at one of its properties and staying out of new development opportunities.

We believe that our recent decisions to terminate the purchase option on the Fifth + Bank property, waive on three attractive development opportunities with Minto Properties Inc. ("MPI"), and delay the construction start of the High Park Village intensification, demonstrate this focus.

Source: Press Release

Verdict

Minto is cheap and cheaper than it has probably ever been. The market is pricing this REIT at 5.5% cap rate, whereas the REIT believes its portfolio to be a little more than 4%.

The gap from its consensus NAV is monstrous currently, and we have a good degree of faith in this NAV.

Another residential REIT that we like, Dream Residential Real Estate Investment Trust ( DRR.U:CA ) has an even larger discrepancy between the implied and the internally calculated NAV. We are bullish on that one's prospects and while in MINTO's case, the gap (difference between NAV cap rate and implied cap rate) is smaller, we still like it and rate it a buy. One common theme for both is that are we are getting a wide enough margin of safety and they both have a great debt profile. The current market environment is difficult for REITs, so upside may not come instantly, but this looks like a buyout candidate for anyone looking to buy quality apartment properties for cheap.

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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