Tricon Residential Inc. (NYSE:TCN) Q1 2023 Earnings Call Transcript

Tricon Residential Inc. (NYSE:TCN) Q1 2023 Earnings Call Transcript May 10, 2023

Operator: Good morning. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Tricon Residentials First Quarter 2023 Analyst Conference Call. [Operator Instructions] Thank you. I’d now like to turn the conference over to your speaker today, Wojtek Nowak, Managing Director of Capital Markets. Thank you. Please go ahead.

Wojtek Nowak: Thank you, operator, good morning everyone, and thank you for joining us to discuss Tricon first quarter results for the three months ended March 31, 2023, which were shared in the news release distributed yesterday. I would like to remind you that our remarks and answers to your questions may contain forward-looking statements and information. This information is subject to risks and uncertainties that may cause actual events or results to differ materially. For more information, please refer to our most recent management’s discussion and analysis and Annual Information Form which are available on SEDAR, EDGAR and our Company website, as well as the supplementary package on our website. Our remarks also include references to non-GAAP financial measures, which are explained and reconciled in our MD&A.

I would also like to remind everyone that all figures are being quoted in U.S. dollars unless otherwise stated. Please note that this call is available by webcast on our website and a replay will be accessible there following the call. Lastly, please note that during this call, we will be referring to a slide presentation that you can follow by joining our webcast or you can access directly through our website. You can find both the webcast registration and the presentation in the Investors section of triconresidential.com under News and Events. With that, I will turn the call over to Gary Berman, President and CEO of Tricon.

Gary Berman: Thank you, Wojtek, and good morning everyone. We’ve had a great start to 2023, and I’m excited to discuss our Q1 results with you. Let’s turn a Slide 2, so I can share with you our key takeaways for today’s call. First, we delivered another solid quarter of operational performance with no evidence of economic weakness in our single family rental business. We reported same home NOI growth is 6.2%, a near record NOI margin of 69.5%, high occupancy of 97.3%, low turnover of 16.8%, and consistently strong blended rank growth of 7.2%. Second, we continue to grow responsibly, acquiring 409 homes during the quarter. In response to significant demand for our homes, we plan to double our acquisitions in the second quarter as the MLS listing volume increases during the spring selling season.

We remain committed to growing our business over the long term in a strategic and responsible way. Third, we are focused on process improvement and cost containment during this period of slower growth by driving cost savings and corporate overhead and property operating expenses. At the same time, we strengthened our balance sheet by refinancing over $100 million of near-term maturities on a proportionate basis and reducing our floating rate debt exposure to 26% from 29% last quarter. And finally, when market conditions do improve, we are well-positioned to grow with about $55 million of annualized AFFO less dividends and $2.6 billion of available capital, including liquidity in our balance sheet and third party unfunded equity commitments.

On Slide 3, as we spoke about our Investor Day in April, we continue to see a major valuation disconnect between our share price and our fundamental value drivers such as book value per share and NOI growth. When we take a step back and look at it, our net operating income has grown at a compounded rate of 18% per year since 2019. Our book value per share has also grown by 16% since 2019. Interestingly though, our stock price is now back to 2019 levels, which doesn’t make much sense when you look at the value that’s been created since that time. So now let’s look at the interplay between private and public market cap rates on the right hand side of the page. What’s different about single family rental when compared to other commercial real estate sectors is, this one of the largest most liquid asset classes in the world.

There is no price discovery per say. And there is no bid-ask spread. This is because every single day there are thousands of transactions to validate pricing. That’s why we feel confident about our own internal valuation of 5% flat cap rate based on stabilized NOI and 6% when including the loss to lease in our portfolio. Green Street derives the similar valuation or an implied weighted average cap rate of 4.7% for our market coverage through the cap rate observer publication. It’s true that right now we are acquiring homes close to a 6% cap rate, but that’s only because we are buying small volume. If we wanted to go back to acquiring a large volume of homes every year, let’s say, 8000 or 10000, we believe the cap rate will be closer to 5.25%.

So let’s compare that with the public market. Tricon is currently trading at a 7.5% cap rate based on stabilized NOI. If you include the loss to lease in our portfolio, we are closer to 9%. This shows a massive disconnect between where the public and private markets are trading. We think that overtime the public market should catch-up. There seems to be a lot of value to unlock for our shareholders, and we believe that this is a tremendous opportunity to own Tricon for those that have a longer-term investment horizon. Moving to Slide 4. Demand for our rental homes continues to be robust. To show this, we focused on two key indicators, monthly leads and monthly applications per available home. You can see that seasonality was more pronounced in Q4 than in prior years with leads and applications dipping.

However, the rebound in Q1 into April has been very healthy with leads and applications even higher than what we were seeing before the pandemic. This makes for a very supportive demand backdrop, as we head into the busy spring market. Turning to Slide 5. You can see that the rental supply has been increasing post-pandemic. We think this is partly due to the lock in effect of low in place mortgage rates, which is incentivizing some homeowners to rent out their homes rather than selling them. What’s interesting is the supply looks like it’s starting to stabilize at levels that are slightly below, what we saw pre pandemic. Anecdotally, this finding brief of research that was recently published by the National Rental Home Council showing that over the past decade, the proportion of single family rentals within the overall single family housing market has actually shrunk by 1.4%.

When taken together, the combination of rising demand for rental housing and stabilizing supply of rental homes provides a compelling backdrop for our business. On Slide 6, you can see how this translates into rent growth, which remains well above pre pandemic levels that were already strong to begin with. Our rank growth in April remains resilient and is slightly ahead of Q1, featuring 11.9% growth on new leases and 6.5% on renewals for blended rank growth is 7.6%. Turning to Slide 7. Let’s talk about the general state of the housing market and what the opportunity set looks like for acquisitions. Within our target markets, prices of homes that meet our buy box have declined roughly 4% year-over-year. Our rents are actually up 3%. Together, this combination of moderated home prices and slightly higher rents has led to an expansion and cap rates of about 30 basis points.

While this is directionally positive, MLS listings volume in our market has declined roughly 20% year-over-year, given homeowners reluctance to sell and forego their proactively priced in place mortgages, thereby reducing our buying opportunity. The good news is both prices and rent seem to stabilize since the beginning of the year and appear to be moving back up. Moreover, listings volume has increased roughly 20% since January and should enable us to acquire homes at a faster pace as we head into the spring and summer months. As you can see on Slide 8, Q1 was a relatively slow quarter for Tricon’s acquisitions, but it’s on target with our expectations. As we look at the Q2, we expect seasonally higher listing volume to provide the opportunity to double our acquisition page from Q1 or remaining discipline in our acquisition criteria.

Recall that we are targeting cap rates of 5.5% to 6%, albeit with a preference close to 6% to match our expected cost of debt financing and to help us generate the mid-teens IRRs we expect in our joint ventures. That being said, foreign costs come down and we were to shift our criteria to a lower target cap rate, let’s say, 5.25% to 5.75% we could buy a lot more homes. With that, I’ll now turn it over to our CFO, Wissam Francis to discuss our financial results.

Wissam Francis: Thank you, Gary, and good morning, everyone. We delivered another solid quarter of financial results, and I want to thank our exceptional team for their hard work and dedication, as we focus on process improvement and cost containment across our business. Let’s turn the Slide 9 to review our key financial metrics for the first quarter. Net income from continued operation was $29 million compared to $150 million last year, which includes $12 million of fair value gains on rental properties against a very strong comp of almost 300 million last year as home price depreciation has moderated in recent months. For FFO per share was $0.14, which is consistent year-over-year, and AFFO per share was $0.11, also consistent with last year, providing us with cushion of support our quarterly dividend with an AFFO payout ratio of 48%.

Lastly, our IFRS book value sends a $13.96 or $18.89 in Canadian dollars of almost 19% year-over-year, and will also note that our book value does not factor in the value of our fee streams. Let’s move on to Slide 10 and talk about the drivers of core AFFO per share. Our signal family rental portfolio delivered 18% year-over-year growth in Tricon proportion NOI. This figure reflects 17.2% revenue growth, which was driven by 5.6% increase in proportion rental home count, 1.1% of higher occupancy, and 8.7% increase in average rent. Our same home NOI also increased by a solid 6.2% this quarter. FFO firm fees increased by 3%, primarily driven by higher Johnson development fees, including 3.5 million earn from large bulk sale of commercial lands.

This was partially offset by a lower property management fee following the sale of the U.S. multi-family rental portfolio in October. In our adjacent residential businesses, the year over year decrease of 6% in FFO reflected strong results in residential development driven by healthy for sale housing demand offset by lower FFO following the sale of the U.S. multi-family portfolio. I want to highlight that both of our US residential business and our Johnson business are a great read through into the overall housing market, and from what we can see today, housing demand is holding up exceptionally well. On the corporate side, interest expense was up as we have a higher debt balance to support the growth of our single family rental portfolio, along with higher average interest rates.

Meanwhile, corporate overhead expenses decreased from last year because of lower AIP LTIP and performance fee expense, which was partially offset by higher G&A and stable salary expense. As we mentioned last quarter, we are laser focused on cost containment in this period of slower growth, and as we see, we are delivering on this commitment. Lastly, the diluted share count this quarter was 0.5% lower than last year due to the impact of our share repurchase program, where we have repurchased over 1.7 million shares so far. Let’s now turn to our proportion debt profile on Slide 11. We have been proactive with addressing our near term debt maturities and floating rate debt exposure, as we said, we would. In Q1, we repaid or refinanced over 140 million of near term maturities with plans in place to refinance or repay all of our remaining 2023 maturities in the coming months.

These near term maturities include two JV subscription lines that are used to fund acquisitions, which will be fully repaid this year by calling on JV capital commitments or we’ll be refinancing into longer term debt. We also have a bank term loan with an extension option and we have already exercised their option to extend this loan by another year. During the quarter, we also refinanced 101 million of floating rate warehouse loans maturing in 2025, and fixed rate loans maturing in 2028. This has helped bring down our floating rate exposure from 29% of total debt last quarter to 26% of this quarter. As a reminder, we use floating rate warehouse lines to find acquisitions in the short term. This is not a permanent part of our capital structure and is an exposure we seek to actively term out and roll into fixed rate instruments.

Over time, as we continue to grow, our percentage of floating rate debt will also continue to go down. I also want to highlight that more than 74% of our floating rate debt is subject to caps, which is explained on Slide 12. Rising interest rates have been a headwind for our floating rate debt as well as new fixed rate debt used to grow the business, but we mitigate some of these higher debt costs with interest rate caps that are now in the money. As you can see on the bottom right hand chart, our interest rate caps saved us approximately 1.4 million of interest rate costs in Q1. If we sensitize the sofa rate for an increase of 25 or 50 basis points, you’ll see that our hedging program effectively cushions two third of that increase. I’ll finish off with Slide 13.

To note, that our guidance for 2023 remains unchanged from the initial guidance that we issued last quarter. We believe we are on track towards our guided range for the full year. As Gary mentioned, our acquisitions are on target so far with the expectation of seasonal acceleration in the summer months. FFO per share and same-home NOI growth are also on-track, even though the components of same-home revenue growth and expense growth were both light, this quarter against the prior year comps. We expect this to normalize in the year ahead. And now to give more insight into our same home metrics, I’ll turn the call over to the wind beneath my wings, our Chief Operating Officer, Kevin Baldridge.

Kevin Baldridge: Thank you, Wissam, and good morning everyone. Our strong first quarter performance is very much a testament to the dedication of our amazing team, our people first approach and our best-in-class operations. We’ve had a great start to the year and we’re only getting started. Let’s move to Slide 14 to talk about the drivers of our same-home NOI growth of 6.2% for the quarter. On the top-line, revenue growth was driven by a 7.4% increase in average in place rents that were partially offset by a 60 basis point decrease in occupancy, as we shifted slightly to our rent growth bias going into the spring months. Our rent growth remains healthy with blended rent growth of 7.2% during the quarter underpinned by 10.3% growth on new move in and 6.5% on renewals.

Our renewals reflect our policy of self governing, which maintains rent growth below market levels for existing residents, helping them to stay in their homes longer and as a byproduct keeps our turnover low. As we moved into April, we saw demand continuing to strengthen with rent growth coming in at a healthy 11.9% on new leases, 6.5% on renewals and 7.6% on a blended basis. Our bad debt expense, which is embedded in the revenue numbers, has been tracking around 1.2% compared to 0.5% in the first quarter of the prior year, when we benefited from the significant government rental assistance payments. I should note that, our bad debt has improved significantly from a pandemic high of 2.9%. And looking ahead, we continue to target bad debt of 1% of revenues by the end of this year.

Finally, other revenue decreased by 13% from last year. This was driven by lower late fees as our collections have improved coupled with more conservative provisioning for resident recoveries to reflect actual collections rather than build amounts. This was partially offset by revenues earned from services that enhance our resin experience like smart home and renters insurance, which saw increased adoption year-over-year. Overtime, we do see a path to increasing other revenue, as we continue to focus on rolling out additional services that add value to our residents. Let’s now turn to Slide 15 to discuss our same-home expense growth of 2%. The slight rise in expenses was driven by property taxes, which were up 10% from last year, reflecting meaningful home price appreciation in our markets.

We still expect property tax to be up around 8% for the full year, but are comping against a relatively low accrual in Q1 of last year. On the other hand, repairs and maintenance expenses were down this quarter by 20.5%. Although we experienced higher work orders as well as cost inflation, we were able to offset this by cost containment initiatives, refining our work scope and undertaking more work orders in house. We now have about 75% of our available work orders completed in-house and are on track towards our goal of 80% by the end of the year. We also benefited from higher refunds in the order through our vendor rebate program, which helped to bring down R&M expense. Turnover expenses were also meaningfully down as our turnover remained low at 16.8%, thanks to our focus on superior customer service, along with a greater proportion of cost being capitalized, given more extensive work being done on homes with longer resident tenures.

Likewise, we’ve put in place process improvements and cost containment initiatives that have brought down to combined expensed and capitalized turnover costs by 14% compared to last year. Next, homeowners’ association’s costs increased by 14.5%, reflecting about 5% inflation in HOA dues as well as a heightened level of violations imposed by HOAs coming out of the pandemic, which drove higher penalties. And finally, other direct expenses increased from having a higher penetration of smart homes in our portfolio and increased utility costs. We remain focused on the things that we can control to offset rising costs, while keeping an emphasis on creating the best resonant experience possible. With this, I wanted to walk through our proactive approach to managing our costs to maintain on Slide 16.

I’m pleased to report we reduce the cost of maintained by 3% year-over-year. We really think of three main areas of savings. First, our national procurement program, we’re focused on negotiating price reductions on materials to help offset inflationary pressures; next, our scope management where we actively refine and manage work scopes; and finally, our internalization efforts where we use our in-house team to undertake a higher number of work orders versus using outside vendors. Our in-house technicians cost per work order is about $400 cheaper than using a vendor for similar work. We are also seeing a stabilization in the mix between capitalized and expensed items. Recall that over the last few quarters, we have seen a higher mix of CapEx compared to the prior year, given the more extensive work required to turn and maintain our homes.

This was partially driven by longer resident tenure, which is almost a year longer than it was at this time last year, and it’s also a function of people spending 24 hours a day in their homes during the pandemic, which created more wear and tear. We are starting to lap those coms, and so the mix of CapEx versus OpEx should be less of a driver of expense variants going forward. Turning to Slide 17, I’m thrilled to introduce to you our proprietary resident app, which some of you saw at a recent investor day. We’re super excited about this app as it provides a one stop shop for our residents where they can control their smart home devices, pay their rent, submit maintenance requests, and track their work order progress, all in a single sign-on app.

They can even monitor our maintenance technicians, while they transit to their home in an Uber style function, which we think is really cool and adds an elevated level of convenience and transparency to our resident experience. Our goal is to investment in technology that improves the lives of our residents, and we’re happy to see this app going live in nine markets so far, and serving over 5,000 residents and counting. We have plans to roll out to all markets within the next year. We’re not only innovating in our operations and resident experience, but also in our pursuit of our ESG objectives, as shown on Slide 18. We recently released our third annual ESG report. One of the highlights in this report is the progress we’ve made on addressing our environmental footprint.

We developed an industry first energy consumption model to estimate the baseline environmental footprint in our SFR portfolio and attract future improvements as we make our homes more sustainable. Given that the utilities in our homes are controlled by our residents, we don’t directly control the energy use in each of our single family homes. However, with our consumption model, we can now measure and meaningfully improve the energy usage and emissions of our homes through the choices we make on our systems and components we install when we build and renovate. Secondly, we officially launch our down payment assistance program and made our first down payment contribution to our Atlanta Resident Kelsey. This program provides $5,000 to qualified Tricon residents who want to purchase a home of their choice.

We could not be happier for Kelsey in our new chapter as a homeowner, and we wish are all the best. And since then, I’m also pleased to report that we have had another five residents benefit from this program and another one who is currently in escrow. At Tricon, we are deeply committed to providing housing optionality for our residents, including the ability to either rent or own a home as we aim to be part of the solution in addressing America’s significant shortage of housing options. Now, I’ll turn a call back over to Gary for closing remarks.

Gary Berman: Thank you, Kevin. Before we close things off I did want to highlight the incredible multi-family portfolio that we’re quietly building in Toronto as showcased on Slide 19. The portfolio is advancing quickly with close to 1,300 units delivering this year and the majority of projects are already under construction. Our latest project with Taylor is currently three months ahead of schedule, achieving 64% lease up by the end of March with average monthly rents of CAD4.55 for square foot. As this portfolio is stabilized over the next few years, we estimate it we’ll have a gross asset value close to $3.2 billion, creating a lot of strategic optionality for Tricon. Moreover, the book value for share of our stake in this portfolio is expected to double from $0.89 to $1.74 per share upon stabilization, creating meaningful value for our shareholders.

To finish off on Slide 20, as we look ahead to another exciting year, we want to emphasize the following messages for you. First, the value of our company’s underpinned by our SFR portfolio, which continues to perform extremely well and is reflected in our book value for share that is well above our share price; next, we believe in responsible growth. We are prudent in our capital allocation discipline with our cap rate criteria and laser focused on cost containment during this period of slower growth. And finally, we have the platform, people, technology and available capital to grow much faster when the time is right. I will now pass the call back to the operator to take questions. Wissam, Kevin, and I will also be joined by Jon Ellenzweig, Andy Carmody, and Andrew Joyner to answer questions.

Q&A Session

Operator: [Operator Instructions] Your first question is from the line of Mario Saric with Scotia Bank. Your line is open.

Operator: Your next question comes from the line of Brad Heffern with RBC Capital Markets.

Operator: Your next question is from the line of Handel St. Juste with Mizuho. Your line is open.

Operator: Your next question is from the line of Eric Wolfe with Citi. Your line is open.

Operator: Your next question is from the line of Keegan Carl with Wolfe Research.

Operator: Your next question is from the line of Adam Kramer with Morgan Stanley. Your line is open.

Operator: Your next question comes from the line of Stephen MacLeod with BMO Capital Markets. Your line is open.

Operator: [Operator Instructions] Your next question is from Jade Rahmani with KBW. Your line is open.

Operator: There are no further questions at this time. I’ll turn the call back over to Gary Berman, President and CEO of Tricon Residential.

Gary Berman: Thank you, Brent. I’d like to thank all of you on this call for your participation. We look forward to seeing many of you in June at the Nareit Conference and speaking with all of you again in August to discuss our Q2 results.

Operator: This concludes today’s conference call. You may now disconnect.