Tricon Residential Inc. (NYSE:TCN) Q3 2023 Earnings Call Transcript

Tricon Residential Inc. (NYSE:TCN) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: [Call Starts Abruptly] [Operator Instructions] I would now like to hand the conference over to your speaker today, Wojtek Nowak, Managing Director of Capital Markets.

Wojtek Nowak: Thank you, operator. Good morning, everyone, and thank you for joining us to discuss Tricon’s third quarter results for the 3 months and 9 months ended September 30, 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. Before we start, I want to take a moment to thank our exceptional team who played a critical role in the strong results we’re presenting to you today. Our team’s unwavering dedication to our residents and the communities we serve is fundamental to our culture, and I believe it’s one of the key reasons our company continues to perform well quarter after quarter. Let’s turn to Slide 2, so I can share with you our key takeaways for today’s call. First, we delivered another great quarter of operational performance with same home NOI growth of 6%, NOI margin of 68.5%, occupancy of 97.4%, turnover of 18.8% and consistently strong blended rent growth of 6.8%. Second, as always, we remain laser-focused on driving sustainable long-term shareholder value amidst the volatile capital markets backdrop by recapturing our SFR loss-to-lease, driving overhead efficiency and advancing our Canadian multi-family developments.

Third, we remain disciplined with acquisitions. We acquired 410 homes in the quarter largely through our capital recycling program, where we’re essentially selling at a low 4% cap rate and reinvesting the capital at 6 caps. I’m also happy to report that we’ve now substantially completed the investment programs of SFR JV-2 and homebuilder direct joint ventures and are now gearing up to launch JV-3. In terms of guidance, we’ve maintained our full year outlook for Core FFO per share of $0.55 to $0.58, tightened our same home NOI growth of 6% to 6.5%, and slightly lowered our full year acquisitions guidance to 1,850 homes. And finally, we are well positioned to grow with about $60 million of annualized AFFO less dividends, $433 million liquidity, and most importantly, strong interest from private institutional capital to invest in SFR.

Institutional investors remain enthusiastic about SFR and are increasingly viewing the sector as a core or core plus investment opportunity, which should enable us to raise strategic capital with lower leverage parameters in a higher-for-longer environment. Turning to Slide 3. I want to step back for a minute and touch on the compelling fundamentals that underpin our SFR business. While we are clearly operating in a difficult macroeconomic environment at this time, we believe SFR remains one of the most attractive real estate investment opportunities this decade. The story is very simple. Demand for housing is outstripping supply. Demand is being driven by demographics, and right now, the millennial demographic cohort is in its prime years of household formation.

Millennials represent a larger group than the baby boomers and they need quality, affordable homes in good neighborhoods as they form their own families. Meanwhile, the supply of new housing is not keeping up with demand. Ever since the great financial crisis, America has been underbuilding homes and the housing intensity, as measured by housing starts per thousand persons, remains below prior recessionary levels. As a result of this demand-supply imbalance, homeownership has become less accessible, as shown on Slide 4. Over the past 20 years, the median price of a home in the U.S. has grown from 3.9x average household income to a far less affordable 5.2x average household income today. This increase was mitigated somewhat by ultra-low interest rates over the past few years, but now that’s no longer the case as the 30-year mortgage rate has skyrocketed towards 8%.

In such a distorted environment for homebuyers, the case for rental is more compelling than ever. In fact, what’s astonishing is that owning a single-family starter home today costs $1,000 more per month than renting the same home. This is what makes single-family rental so compelling for many American families. So turning to Slide 5. It’s no wonder that SFR operating fundamentals remain so solid. Some might ask, why buy when you can rent a professionally managed home for much cheaper? What’s interesting is that notwithstanding the turbulent times we are living in, SFR operating performance remains remarkably steady. Key indicators, including NOI growth, occupancy and turnover remain robust and consistent when compared to these same metrics 2 years ago when we were emerging from the COVID pandemic and enjoying extremely low interest rate environment.

Whereas, SFR is steady as she goes, housing affordability has eroded significantly and the capital markets backdrop has been dismal. The broader U.S. REIT Index is down by over 30% in 2 years, while the U.S. 5-year treasury yield has more than quadrupled. In this very dislocated environment, we’re doing what we always do, focusing on the things we can control. First on the list is acquisitions. As you can see on Slide 6, we’re being thoughtful with acquisitions and are focusing our efforts on our capital recycling program rather than growing the portfolio. We’ve been able to sell older homes in less desirable locations at very attractive cap rates, near 4%, and recycled the proceeds to acquire newer vintage homes in our core markets that address the growing demand for our renters, require less CapEx to maintain and earn going in yields of 6%.

So far this year, we sold 533 homes with gross sale proceeds of $191 million and in turn acquired 546 homes for a gross investment of $170 million. And by matching dispositions with acquisitions, we expect to save $20 million in tax expense this year through a tax-efficient 1031 exchange program. We remain focused on external growth over the longer term, but won’t ramp up acquisitions again until we officially launch our new SFR JV. In a period of slower acquisition growth, we’ve been able to focus more on the revenue and expense performance of our existing portfolio. A key opportunity in this regard is the embedded loss-to-lease, which we discuss on Slide 7. Our policy of self-governing on renewals, coupled with longer resident tenure has resulted in an estimated loss-to-lease of about 11% across our total proportion portfolio and around 14% in our same-home portfolio.

Most of that loss-to-lease is sitting with residents that have been in our homes for 3 years or more, and represents an opportunity of about $40 million in annualized revenue. We haven’t captured much of this loss-to-lease on recent lease trade-outs because these same residents are staying in our homes longer and represent only 1/3 of our turnover in a given quarter. Our plan to recapture the sizable mark-to-market is to push renewal rent growth, which has been trending up post pandemic, and to responsibly raise rents above our self-imposed caps in situations where residents have significant loss-to-lease. We’re still being thoughtful in our approach with residents who are seeking to strike the balance when the delta between existing rent and market rent is large.

But more importantly, we believe the loss-to-lease opportunity provides a multiyear runway for sustained rent growth on renewals, which is the key driver of overall revenue and NOI growth for Tricon. Looking at Slide 8, I want to point out that the long-term benefits of our resident-friendly approach to revenue management. Over time, our renewals have been below those of our industry peers, but new lease growth has been stronger and turnover has been much lower, resulting in low turnover costs. These factors have combined to produce industry-leading same-home NOI growth over the longer term, which we believe is the crux of what drives sustainable long-term shareholder value. And finally, and thinking about the things we can control, I’d like to share with you on Slide 9 an update on our Canadian multi-family built-to-core portfolio that continues to evolve and achieve new milestones.

I’m delighted to announce that the Taylor achieved stabilized occupancy of over 98% in the quarter and 100% occupancy in October, reflecting its resort quality amenities, exceptional living spaces and sustainability leadership among other features. I’m also thrilled to introduce our latest project, The Ivy, which will begin its initial occupancy by the end of the year. And finally, the launch of Maple House continues to be extremely successful with 30% of the building already pre-leased since launching in Q3. Tricon now has 9 projects totaling over 5,000 units in lease-up, preconstruction or active construction, as shown on Slide 10. And as this portfolio stabilizes over the next few years, we estimate that we’ll have a gross asset value close to $3.6 billion and annualized NOI of $50 million of Tricon share, creating a lot of strategic optionality as Canada’s premier multi-family portfolio with institutional scale.

Moreover, the book value of our stake in this portfolio is expected to double from $0.93 to $1.87 per share upon stabilization, creating meaningful value for all of our shareholders. 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. Q3 was a solid quarter for Tricon, and I want to thank our exceptional team who continue to focus on process improvement and cost containment across our business while continuing to deliver a world-class resident experience. Let’s start with a review of our key financial metrics on Slide 11. Net income from continuing operation was $81 million compared to $178 million last year, which includes $73 million of fair value gains on rental properties against a strong comp of $107 million last year as home price appreciation has moderated in recent months. Core FFO per share was $0.14, down $0.01 year-over-year. AFFO per share was $0.11 from last year, providing us with ample cushion to support our quarterly dividend with AFFO payout ratio of 46%.

And lastly, our IFRS book value stands at $14.30, that is CAD 19.30, just up over 4% year-over-year. And I will note that our book value does not factor in the value of our strategic capital fee streams. Let’s move on to Slide 12 and talk about the drivers that contributed to our FFO per share variance. The year-over-year decrease of $0.01 can be attributed to strong NOI growth from the SFR portfolio being offset by higher borrowing costs, lower performance in acquisition fees and the absence of Core FFO from U.S. multi-family portfolio, which was sold in Q4 2022. Specifically, our single-family rental portfolio contributed $0.02 of incremental FFO, reflecting revenue growth of 10.5%. This was driven by a 2.2% increase in proportionate rental home count, 5.9% increase in average rent and 0.5% higher occupancy.

FFO from strategic capital had a $0.02 negative impact, primarily driven by lower performance fees from legacy residential development, lower acquisition fees as a result of fewer SFR acquisitions and lower property management fees following the sale of the U.S. multi-family portfolio in Q4 of last year. Our adjacent business added $0.01, reflecting strong results in residential development as housing fundamentals remained robust. Interest expense had a $0.03 negative impact mainly due to higher average interest rates on our debt. And lastly, there was a $0.01 positive impact driven by lower overhead expenses compared to last year. On that note, I want to take a minute and dive into our corporate overhead expenses. Turning to Slide 13. At a high level, our corporate overhead expenses support a world-class operating platform that we have built over the years.

This platform is a source of competitive advantage and creates a moat around our business that is difficult to replicate. It means having a strong local market presence to provide an exceptional resident experience through internal property management and maintenance capabilities. Our strong service offerings has earned us an industry-leading Google score of 4.6 stars. It means being a people-first company and fostering a purpose-driven culture so that our employees will go above and beyond to serve our residents, which in turn leads to lower turnover and strong NOI growth. It also means being a leader in innovation in order to drive operating efficiencies, continually improve our resident experience and scale our business efficiently and cost effectively.

When we break down our corporate overhead expenses on Slide 14, you can see that they support both our SFR operating platform as well as our adjacent businesses, whose overhead costs are more than offset by fee revenue earned from managing strategic capital associated with these businesses. If we just looked at our SFR overhead and compare it to our largest peer, there’s still a delta in terms of efficiency. Recall that we had set our goal of reaching 50,000 homes by 2024 and built a platform to supports such scale, but the goal has been pushed out given the rapid increase in interest rates and the need to pull back on acquisitions for the time being. That said, we continue to see tremendous opportunity in SFR, and we are laser-focused on keeping overhead costs relatively stable so that we could reach a competitive level of overhead efficiency as we grow the portfolio towards 50,000 homes.

So on Slide 15, our near-term focus is to drive operating efficiency and reduce overhead expenses where possible in the current lower growth environment. Over the past year, we’ve made some progress, including a 4% reduction in gross overhead expenses year-over-year. As we look ahead into 2024, you will see 3 main areas that will help us drive additional efficiency by reducing overhead and growing fees. First, we anticipate launching a new SFR joint venture in early 2024 to add scale as well as strategic capital fee streams. Recognizing that the interest rate environment is still challenging, we expect the new joint venture to accommodate buying homes with lower leverage parameters. What changed over the past year or so is that our institutional investors are increasingly open to lower leverage or no leverage joint venture structures with the expectations of Core or Core Plus returns compared to opportunistic return expectations in the past.

This goes to show how SFR has matured into an attractive and stable institutional asset class. Next, we continue to optimize our workforce to fit our current needs, which included reducing our staffing by approximately 5% over the past several months and reallocating the operating staff from servicing vacant homes and acquisitions to servicing occupied homes. And finally, we are containing G&A costs by focusing on key growth projects and on essential activities only. Now let’s shift gears and talk about our debt profile on Slide 16. We have been proactive with addressing our near-term debt maturities as we said we would, and I’m happy to report that we have repaid or extended all of our remaining 2023 maturities. As we look ahead into 2024 maturities, our 2017-2 securitization is on track for refinancing before it’s maturity in January, and we expect to repay or extend our wholly owned portfolio term loan before its maturity next October.

From there, we can look ahead and start tackling our 2025 maturities as well. I’d like to end by discussing our 2023 guidance that we’ve updated on Slide 17. We are reiterating our guidance range for Core FFO per share of $0.55 to $0.58. We’ve tightened up the expected range for the same-home metrics to 6% to 6.5% for revenues, expenses and NOI. The revenue guidance reflects softer rent growth on new home move-in as well as lower turnovers as turnover tends to skew to residents with shorter tenure, partially offset by gradual increase in rent growth on renewals. The expense guidance is a function of elevated property tax, offset by successful reduction of controllable expenses such as property management, repair and maintenance and turnover expenses.

Kevin will provide more insight into these items later on the call. The outlook for the same-home metric is coupled with expectations for ongoing strong results in the U.S. residential development business, which gives us confidence in the overall outlook for the FFO per share. We’ve also taken the pace of acquisition down slightly to 1,850 homes as investment programs for JV-2 and JV-HD are substantially complete, and we are buying homes purely as part of our capital recycling program. As we head into the end of the year, we remain laser-focused on cost control, balance sheet flexibility and prudent capital allocation while keeping an emphasis on creating the best resident experience possible. And now to give you more insight into our same-home metrics, I’ll turn the call over to our Chief Operating Officer.

He’s just Kevin. Anywhere else he’d be a 10, but for us, he’s an 11, Kevin Baldridge.

Kevin Baldridge: Thank you, Sam, and good morning, everyone. First and foremost, I want to give a big thank you to our Tricon’s operations and customer service teams who helped deliver this quarter’s outstanding results. I continue to be so impressed with our extraordinary team and the exceptional care they provide our residents day in and day out. Let’s move to Slide 18 to talk about the drivers of our same-home NOI growth of 6% for the quarter. On the top line, revenue growth was driven by a 6% increase in average monthly rent that was partially offset by a 20 basis point decrease in occupancy. This remains well within our targeted range of 96.5% to 97.5% as we balance rent growth versus occupancy through the seasons.

Our rent growth remains healthy with blended rents increasing 6.8% during the quarter, underpinned by 6.9% growth on new move-ins and 6.7% on renewals. As we moved into October, demand remained consistently strong with rent growth coming in at 6.8% on a blended basis, supported by 6.6% on new leases and 6.8% on renewals. Our bad debt expense, which is embedded in the revenue numbers has continued to inch down as we thought it would due to the successful collection efforts of our team in the field and is now near pre-pandemic levels of 0.9% versus 1.4% in Q3 of last year. Finally, other revenue decreased by 0.9%, down slightly 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 cash collections rather than billed amounts.

This was partly offset by revenues earned from services that enhance our resident experience like Smart-home and Renters Insurance, which both saw increased adoption year-over-year. Let’s now turn to Slide 19 to discuss our Same Home expense growth of 7.5%. The rise in expenses was primarily driven by property taxes, which were up 10.5% from last year, reflecting meaningful home price appreciation in our markets. To date, we have received 50% of the tax bills for the Same Home portfolio and expect another 25% in November, 19% in December and the balance early next year. So far, we have seen higher-than-expected assessed value increases in Atlanta, Texas and the Carolinas, which account for about 60% of our tax expense. This has been partly offset by millage rates and successful appeals, but not to the extent that we would like.

From where we sit today, our best guess is that taxes are up 12% year-over-year, which would put us near the high end of Same Home expense guidance. Yet, if we see favorable millage rates and appeals, we could end up at the low end of expense guidance. Moving on to the other expense lines. Repairs and maintenance expense was up this quarter by 2.3%. This reflects an 8% increase in completed work orders, which was partially offset by our ongoing cost containment efforts. And our turnover expense continues to remain low, a strong testament to our policy of self-governing on renewals and industry low turnover rate as well as cost containment efforts. Next, Homeowner’s Association costs increased by 25%, reflecting inflation in HOA dues as well as a heightened level of violations composed by HOAs coming out of the pandemic, which drove higher penalties.

And finally, other direct expenses increased primarily from the upfront cost of providing Smart-home technology to more residents and increased utility costs. I’m also pleased to report that we achieved a 14% reduction in cost to maintain this quarter compared to last year, which includes repair and maintenance, turnover and recurring CapEx. Our team has been proactive and successful in achieving price reductions through our national procurement program, reducing turn scopes where we aim to repair versus replace where possible and driving higher utilization of our in-house team to undertake more work orders versus using outside vendors. We now have over 77% of our available work orders completed in-house and are on track towards our goal of about 80% by the end of the year.

Our in-house technicians cost per work order is about 45% cheaper than using a vendor for similar kinds of work. As we head towards the end of the year, we remain focused on the things we can control to offset rising costs, while keeping an emphasis on creating the absolute best resident experience possible. Now I’ll turn the call back to Gary for closing remarks.

Gary Berman: Thank you, Kevin. It was another great quarter for Tricon, and I want to conclude my prepared remarks by saying that I feel truly honored to work alongside such a world-class team who deliver an unmatched resident experience every single day. As we approach the end of the year and look forward to 2024, we’re excited about the numerous catalysts that should drive sustainable long-term shareholder value, which we’ve talked about on this call and summarized on Slide 20, including launching a new JV, driving overhead efficiency, continuing to deliver strong rent and NOI growth and advancing our Canadian multi-family portfolio towards stabilization. I will now pass the call back to the operator to take questions with Sam, Kevin, Wojtek and I will also be joined by John Ellenzweig and Andrew Joyner to answer questions.

See also Top 20 Gold Mining Companies in the World and 30 Best Whiskeys Under $30.

Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Brad Heffern.

Brad Heffern: Obviously, the presentation’s out, can you just give your thoughts on their primary recommendations as being quickly marking the rents to market, reducing overhead and exiting the Canadian multi-family business?

Gary Berman: Brad, we don’t comment on any specific conversations that we have with any of our shareholders. We’re always open to constructive feedback from anybody, any shareholder, but we don’t comment on any kind of specific items related to strategy. The only thing I can say that at this point that we agree with is that the stock is mispriced and there’s significant opportunity for those that are going to be patient, make a lot of money, but that’s all I can really comment on.

Brad Heffern: Okay. Fair enough. For the next JV, presumably the partners would want an investment pace that’s above what’s been being executed of late. Do you think that that’s correct, first of all? And then how would you think about funding your capital commitments at faster paces, if needed?

Gary Berman: Yes. I mean that’s — we really aren’t making much in the way of acquisitions right now. Everything is largely focused on balance sheet and through our capital recycling program. And that’s because, obviously, both SFR JV-2 and homebuilder direct are now essentially complete. So yes, as we launch a new JV, let’s call it, JV-3, hopefully, early next year, that will increase the pace of acquisitions, and that is what would be expected by our investors. But keep in mind, we typically have a 3-year investment period and once they commit to a fund, there’s no pressure to put that money out immediately. We can determine at what pace we want to put out and do so when we think it makes sense. So we may form a fund and take our time to put the capital out.

And I think in terms of funding our share, I think one thing you can expect is that the new fund will be sized to the opportunity. Our co-investment will likely be smaller. We will use lower leverage as we talked about extensively on the call and our investors seem to be fine with that. And then we should be able to fund our co-investment with any AFFO less dividends, right? So we talked about that being $60 million a year. That’s going to obviously ramp up as we grow our AFFO. And so we should have ample cash to fund our co-investment over the next 3 years.

Operator: And your next question comes from the line of Haendel St. Juste.

Haendel St. Juste: My first question is on the January refinancing. This time you talked about fixing on track. Maybe you could give us a bit more color on where you think the refi costs would be, the cost of new debt and what sources you’re considering in the likely timing?

Gary Berman: So we launched the deal last night. I’m sure some of you might have seen that. And that deal is really to refinance the 2017-1 — sorry, 2017-2. Right now, I can’t really comment on the spread, but I could tell you we’re getting indications similar to the last time — to the last deal we did. A reminder, the last deal we did, the all-in rate was 5.86%, but the spread was about 1.78%.So we’re getting a similar indication in terms of spread. And the 5-year mark is sitting at $460 million today. So all in, we’re thinking it’s going to be between 6.2% and maybe 6.4% depending on the day we price it. But so far, it’s all been positive indications, and we feel very confident that this will come through over the next several weeks.

Haendel St. Juste: Great. I appreciate that color. And I think you guys talked about — I think you’ll see to responsibly raise the mills above the self-imposed caps where the loss release is sizable. So can you talk a bit about what portion of the portfolio today broadly meets the threshold and how high you’re willing to go on pushing renewals for this?

Gary Berman: Yes. So the way we think about the portfolio on proportion residents is essentially 45%, and we outlined this in the presentation. 45% have been with us for 1 to 2 years and 55% have been with us for 3 years plus. And we’re going to continue to self-govern across the board, but we’ll take 2 approaches to self-governing compared to 1 to 2 years and those that are 3 years plus. And what I mean by self-governing is we’ll continue to set rents below market, slightly below market. The idea there is, obviously, to keep our residents in our homes, which lowers turnover and turnover expense and we’ve seen it drives NOI growth, but to take a more aggressive stance on self-governing with those who have been with us more than 3 years, right?

So that will mean we will push through our caps. I’m not going to give any detail as to how that will work. But I think what’s most important is we think we’ve got several years tailwind with us on renewal rent growth, but we’ll be able to recapture that loss to lease. So when we talked about that $40 million revenue opportunity, we think we can recapture that over a few years. And it could very well mean renewal rent increases of about, let’s say, 6% or 7% per year over the next few years. So that’s in the current environment. Obviously, if there’s an economic recession, things could change. But we think we could have industry-leading renewal rent growth over the next few years because of the sizable loss to lease that we can recapture.

Haendel St. Juste: And then one quick one, sorry. You mentioned the loss to lease, but do you guys — or can you provide an estimate of what the earning is for next year?

Gary Berman: Yes. The earn-in, as of today, the earnings’ 3%, I think if we factor in Q4 rent growth, it’s going to be about 4% heading into 2024.

Operator: Your next question comes from the line of Stephen MacLeod.

Stephen MacLeod: Just a couple of questions here. Just thinking about the acquisition pacing for next year and with having Q4 coming down to that $250 million range, all self-funded. Just wondering if you can give a sort of a starting point for how you expect acquisitions to flow through next year given the timing of the new JV-3?

Gary Berman: Yes. I mean we’re not going to give guidance — any kind of formal guidance today, Steve, for 2024, including on acquisitions. And obviously, the amount of acquisitions will really depend on the timing and the size of our next fund. But it’s fair to say that once that fund gets formed, we will be able to ramp up acquisitions. And those acquisitions, certainly in the short term, could be funded on an all equity basis or low leverage basis. So I wish I could give you more detail, but just to say that you should expect acquisitions to ramp up next year.