Tricon Residential Inc. (NYSE:TCN) Q4 2022 Earnings Call Transcript

Tricon Residential Inc. (NYSE:TCN) Q4 2022 Earnings Call Transcript March 2, 2023

Operator: Good morning, my name is Rob, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Tricon Residential Fourth Quarter 2022 Earnings 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. Wojtek Nowak, Managing Director, Capital Markets, you may begin your conference.

Wojtek Nowak: Thank you, operator. Good morning, everyone, and thank you for joining us to discuss Tricon’s fourth quarter results for the three and 12 months ended December 31, 2022, 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. 2022 marked another record-breaking year for Tricon as we adapted to a difficult macro environment to deliver on our business plan, implement bold strategic initiatives and go above and beyond for our residents. We are exceptional performance to our world-class team and their unwavering commitment to our residents and the communities we serve. As a people first organization our goal has always been to prioritize our employees, so they in turn can provide our residents with inspired customer service. We know that when our residents are fulfilled they rent with us longer, treat our properties like their own and refer other customers. On slide two, I wanted to highlight that I’ve taken time in my 2022 annual letter to shareholders to explain how this virtuous philosophy of doing business leads to strong operations and ultimately good financial results.

The letter also provides some interesting insight into project journey for the sale of our U.S. multifamily business. Our learnings from managing both U.S. multifamily and single-family rental property operations, the benefits of having one foot in the public market and one foot in the private market. How we can use technology to make our business more efficient and improve the customer experience, and our belief that a kinder form of capitalism is the best approach for managing rental housing over the long-term. It makes for some decent bedtime reading. I hope you all time review it, when it’s released later this week. Let’s turn to slide three, so I can share with you our key takeaways for today’s call. First, we delivered another rock-solid operational quarter with single-family rental same home NOI growth of 9.7%, a record high NOI margin of 69.8%.

Near record occupancy of 98%. Record low turnover of 12.2% and consistently strong blended rent growth of 7.4%. Second, we remain disciplined on acquisitions and grow our portfolio by selectively acquiring 815 homes during the quarter. Although we are starting to slow acquisitions into 2023, we remain committed to growing our business over the long-term in a strategic and responsible way. At this time, that means slowing the pace of our acquisitions, until it makes sense to accelerate once more. Third, we are focused on cost containment during this near-term period of slower growth by driving cost savings within corporate overhead and property operating expenses. At the same time, we are encouraged by green shoots emerging the debt markets, as dislocation in the securitization market phase and pricing improves, we may be able to accelerate great growth later this year.

And finally, when market conditions do improve, we are well positioned to grow with nearly $3 billion of available capital, including liquidity on our own balance sheet and third-party unfunded equity commitments. What I love about our model is that we can scale our acquisition program up or down very quickly depending on market conditions. And we will lean in and deploy that capital responsibly and when the time is right. On slide four, we reflect on the past year and our first foray into setting guidance. We are proud to report that we delivered on what we promised and largely exceeded our initial financial targets. By all accounts 2022 was a fantastic year for Tricon, with core FFO per share of $0.76 and same home NOI growth of 10.4%, both well above the high-end of our initial guidance.

In a period of capital market uncertainty and lower transaction volume, we are fortunate to sell the remaining interest in our U.S. multifamily portfolio, generating $319 million of gross proceeds to Tricon and simplifying our business in the process. We also acquired a record of more than 7,200 homes largely one at a time, expanding our portfolio by over 23%. If our cost of capital hasn’t deteriorated in the second-half of 2022, this number would have been even higher. And we recently commenced lease up on our second Canadian multi-family property, The Taylor, which is tracking months ahead of schedule with over 41% of units leased at an average monthly rent of CAD4.42 per square foot, as at December 31, 2022. Last but not least, we continue to prioritize the well-being of our residents by introducing industry-leading Bill of Rights.

The first of its kind for U.S. single-family rental, outlining our commitment to providing quality move-in ready homes with caring and reliable service. We also launched our flagship Tricon Vantage program, a suite of programs and resources available to our U.S. single-family residents to help them realize their financial goals, including the goal of home ownership if they so choose. As you can see on slide five, this year’s accomplishments have added to a long track record of creating value for shareholders. Through our consistently strong operations in active acquisition program, we’ve grown our proportionate NOI and book value per share at a compounded annual rate of 17% and 18%, respectively. It’s clear that real cash flows is driving and underpinning our book value.

And we think that a serious disconnect exists between our depressed stock price and the fundamental value of our underlying real estate and operation. We know that the markets can be inefficient in the short-term, but over time this valuable surface and be realized for our shareholders. Let’s take a look at the current state of our business fundamentals on slide six. The demand for our rental homes continues to be very strong with leads per available home well above pre-pandemic levels. At the same time there is evidence of higher rental supply in our markets, partly caused by would-be home sellers opting to rent at their homes, given the challenging mortgage environment and having attractive legacy mortgages locked in place at very low rates.

Taken together, the combination of strong demand, but higher supply of rental listings over recent months has contributed to a moderation of rent growth on new move-ins. Although rent growth in our same home portfolio remain strong by historical measures and has shown signs of strengthening into 2023. We believe we have a long runway to capture industry high re-leasing spreads, given the 15% embedded loss to lease in our portfolio, which we’ve accumulated by self-governing on renewals over the past few years. And so, we feel good about our revenue trends for the year ahead and believe we can grow same home revenues by 6% to 7.5% in 2023. As we turn our attention to expenses on slide seven, we remain focused on cost control, especially during this period of slower acquisitions.

We see opportunities on two fronts. One is leveraging our existing corporate overhead platform, which we’ve expanded over time to be able to handle a much larger number of homes. This means being very prudent with hiring and G&A costs, while earning incremental property management fees as we grow and complete the investment program for our JV partners. With this, we expect to save $0.03 of core FFO per share and corporate overhead expenses this year compared to last. The second opportunity is to capture efficiencies of scale and our SFR portfolio by bringing more work orders in-house. Leveraging our national procurement programing and using technology to become more efficient, which should help us continue same-home expense growth in the range of 6% to 7.5% this year.

Turning to external growth on slide eight, let’s talk about what the opportunity set looks like for acquisitions. Within our target markets, home prices that meet our buy box criteria have declined by over 8% for mid-year 2022 peak, while rents are down about 5% and stabilizing into January. This is resulting on a slight expansion acquisition cap rates. At the same time MLS transaction volume is down materially, which is largely related to the lock-in effect caused by existing home owners not wanting to trade out of their low mortgage rates. This makes it more difficult for us to acquire a meaningful number of homes that meet our cap rate criteria which is currently in a 5.5% to 6% range, albeit with a preference for cap rates close to 6%. As you can see on slide nine, staying disciplined with this criteria, means that we often need to bid for homes at a meaningful discount to the asking price to make the math work.

Consequently, we end up buying fewer homes today than in the past, often losing out to individual home buyers, who do not buy homes with a cap rate in mind. That being said, if we were to shift our criteria to lower target cap rates, let’s say 5.25% to 5.75%, we could buy a lot more homes. And see you might be asking what’s the magic behind a 5.5% to 6% cap rate. We step back for a moment, our general strategy is to acquire homes at cap rates that are equal to or greater than our cost of debt financing in order to generate potential low teen gross IRRs in our JVs, and potentially higher IRRs for Tricon when we factor in the fees we earn. So, it’s really the cost of available debt financing that dictates our acquisition parameters. With that, I’ll turn it over to Wissam to talk about where the debt markets are today.

Photo by Breno Assis on Unsplash

Wissam Francis: Thank you, Gary. Good morning, everyone. The main take away of acquisitions, is that as financing rates decrease, we can lower our target cap rates and go back to buying more homes. So, let’s turn to slide 10, and see how this is evolving. The debt markets were essentially closed for business from August to January. And then as we moved into February, we were encouraged to see some green shoots with one of our peers completing a transaction at a yield of 5.74%. As Gary mentioned, we generally aim to acquire homes at cap rates that are equal to or greater than our cost of debt financing, in order to meet our target returns. We also have a good sense of the depth of the market at various cap rates. And so, if we assume both debt financing and cap rates of 5.75%, we should be able to buy between 800 and 1,200 homes a quarter, like we did in Q4.

In order to go back to higher acquisition volumes, we would need one of two things. Either see the financing costs revert to 5.25% to 5.5% or we would look towards financing at lower loan to values where the debt costs are cheaper. This is a real possibility and it’s something we are discussing with our joint venture partners. Either way, we are optimistic that slightly lower financing cost will allow us to accelerate acquisitions later this year. Let’s turn to slide 11, to review our key financial metrics for both — for the fourth quarter. Net income from continuing operations was $56 million, compared to $110 million last year, which includes $56 million of fair value gains on rental properties against a very strong comp of $262 million last year, as home price appreciation has moderated since.

Core FFO per share was $0.31, an increase of 107% year-over-year. AFFO per share was $0.28, up 133% year-over-year, providing us with ample cushion to support our quarterly dividend with an AFFO payout ratio of 18%. Both core FFO and AFFO per share benefited from net performance fees earned on the sale of the U.S. multi-family portfolio this quarter, which amounted to $0.16 per share. Lastly, our IFRS book value stands at $13.89, that’s CAD18.83, up almost 24% year-over-year. I will also note that our book value does not factor in the value of our private funds and advisory fee streams. Let’s move to slide 12 and talk about the drivers of core FFO per share. Our single-family rental portfolio delivered 24% year-over-year growth in Tricon’s proportionate NOI.

This was driven by an 8.9% increase in proportionate rental home count and 9.7% increase in the same home NOI. FFO from fees increased materially due to the $100 million of performance fees received upon the sale of the U.S. multi-family portfolio. In our adjacent residential businesses, the year-over-year decrease of 63% in FFO reflected the sale of the U.S. multi-family portfolio and lower results from the U.S. residential development as market conditions have normalized versus a very strong comp in prior year. 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 increased from last year, due to the $50 million of performance fees related LTIP and performance fee expense associated with the sale of the U.S. multi-family portfolio.

If we would exclude these expenses, overhead cost is actually down year-over-year by $2 million, as we continue to focus on cost containments in this tougher operating environment. Lastly the diluted share count this quarter was 2% higher than last year, from the residual impact of the U.S. IPO, capital raising initiatives in the prior year. Now let’s turn to proportionate debt profile on slide 13. Our near-term debt maturities consists of two subscription lines used to fund acquisitions, as well as the bank term loan, which we will expand later on this year. In terms of leverage, we ended the quarter at 7.2 times net debt to adjusted EBITDA, which is below our near-term target of 8 times to 9 times and excludes the impact of our performance fees earned in the quarter.

Our floating rate debt exposure notched down to 29% of total debt, compared to 31% last quarter. As a reminder, we use floating rate warehouse lines to fund acquisitions in the short-term. This is not a permanent part of our capital structure and is an exposure that we actively seek to term out and roll into fixed rate instruments, when we have a large enough pools of homes to do so. I also like to highlight, that more than 73% of this floating rate debt is subject to caps, which are explained on slide 14. While rising interest rates have been a headwind in 2022, our interest rate caps have also recently started to kick in. And we should help mitigate some of the impact of rising rates in 2023. And now to get more insight into our same home metrics, I will turn the call over to our very own David Hasselhoff, our Chief Operating Officer, Kevin Baldridge.

Kevin Baldridge: Thank you very much, Wissam, and good morning, everyone. I wanted to start out by giving a big shoutout to our amazing front line operations team for their hard work and tremendous commitment to enriching the lives of our residents this past year. I’m incredibly proud for the operating metrics we’ve been able to achieve, while remaining true to our values and taking care of each other, our residents and our communities. Let’s move to slide 15 to talk about the drivers of our same home NOI growth of 9.7% for the quarter. On the top line revenue growth was driven by 7.7% increase in average in-place rents and a 20-basis point gain in occupancy. Blended rent growth increased by 7.4% during the quarter supported by a 11.5% growth on new move-ins and 6.8% on renewals.

Our renewal spreads reflect our policy of self-governing, which typically maintains rent growth below market levels for existing residents, which in turn helps keep our turnover low. Over time, the last lease of about 15%, that we’ve built up in our portfolio has allowed the renewals to pick up, while still offering our residents below market rents, which is a win-win in our books. And as we moved into the new year, I’m pleased to report solid demand trends continuing, with 13.9% new lease growth and 7.3% blended rent growth in January. Our bad debt expense which is embedded in the revenue numbers has been tracking around 1.3%, compared to 1.8% in the prior year. And we aim to move it down to pre-pandemic levels of 1% or lower by the end of this year.

It’s hard work and we rely on the tremendous efforts of our collections teams to ensure collections are on time, while being compassionate to our residents individual situations. And working with them towards in agreeable solution. Other revenue decreased by 18% from last year. This was partly driven by improved collections, which helped to reduce our bad debt, but also results in lower late fee revenue. As well our record low turnover is resulting in lower ancillary revenue for things like early lease termination fees and resident recoveries on turns. However, over time we do see a path to increasing other revenue, as we continue to rollout value added programs such as smart home technology and renters insurance, which are embedded in these numbers and increased by almost 20% year-on-year.

Let’s now turn to slide 16 to discuss our same-home expense growth of 0.8%. The slight rise in expenses was mainly driven by property taxes, which were up 10.7% from last year, reflecting meaningful home price appreciation in our markets. We were a touch conservative on our tax accruals during the year and have trued up in Q4, based on final tax assessments, which resulted in a 13.4% increase for the full-year. On the other hand, repairs and maintenance expenses were down this quarter by 11.6%. Although the portfolio experienced higher volume of work orders, as well as cost inflation post-pandemic, we were able to offset this in part by completing 75% of our work orders in-house or 6% more year-over-year, which in turn saves us about $400 per job.

Turnover expense was also down significantly as our turnover rate decreased by over 310 basis points to a record low of 12.2%. Thanks to our occupancy bias and focus on superior customer service, and what is already a seasonally slow period for move-outs. Because of our longer resident tenures and people generally spending more time in their homes during the pandemic, we had more extensive turn, such that a greater proportion of turn costs ended up being capitalized. You can see in the table on the right that our same-home cost to maintain, which includes expensed and capitalized activities rose by 14% for the full-year. Next on property management expenses, we’re seeing inflationary pressures and labor costs offsetting some of the efficiencies of scale that we’ve achieved as our portfolio has grown.

And finally, homeowners’ association costs increased, as it was a year-end true-up of HOA bills. But we also are seeing a heightened level of restrictions imposed by HOAs coming out of the pandemic, which drove the higher HOA fees. In this higher interest rate environment, our focus remains on continuing the expenses that we can control. This includes the leveraging our national procurement program, driving efficiencies through technology, and making operational improvements wherever we see the opportunity. All the while creating the best resident experience possible. Let’s turn to slide 17 to dig deeper into more recent leasing trends and give you some insight into how we manage revenues. Demand trends were solid in Q4, but you can see the slight moderation in new lease rent growth, as we took an occupancy bias to lease up homes in the seasonally weaker holiday period.

As we rolled into January, we shifted back towards the rent growth bias, keeping homes on the market a bit longer to achieve our target rents with a minor loss of occupancy. This way we can effectively capture our loss to lease on new leases, while continuing to self-govern on renewals for existing residents. We expect these rental trends to persist, as we anticipate a relatively strong leasing season into the spring. Now I will turn the call back to Wissam Francis to introduce our 2023 Guidance.

Wissam Francis: Thank you, Kevin. Moving on to slide 18, I’m pleased to introduce our 2023 Guidance, which brings together many of the themes and messages we’ve discussed on today’s call. Core FFO per share is expected to be between $0.54 and $0.59 in 2023. Compared to last year, we leased about $0.16 from the net performance fees from the U.S. multi-family transaction and another $0.04 related to the recurring fees in FFO from this U.S. multi-family portfolio. Net of overhead savings, bringing the total impact to $0.20, this creates a baseline for FFO of (ph) as a starting point. We expect NOI growth to contribute $0.13, which is being largely offset by higher interest expense of $0.12. Roughly half of this is already baked into our Q4 run rate and the remaining half comes from incremental debt to fund acquisitions.

Hence the impact of NOI less interest is $0.01 for the positive, getting us from $0.56 baseline to $0.57 guidance midpoint. Aside from this, we expect $0.03 of overhead cost savings at the corporate level, offset by $0.03 of income tax variances and lower acquisition fees. Note that the income tax was recovery in 2022 and we expect a minor tax expense in 2023. Getting to the high end of guidance from the midpoint is largely driven by the higher end of same-home NOI guidance and the higher end of acquisition guidance, which drives the acquisition fees. Our same home metrics are expected to moderate from 2022 levels, but will still remain very robust. Same home revenue growth of 6% to 7.5% assumes rent growth on new leases and the 9% to 11% range, and rent growth on renewals near current levels of 6% to 7% as we continue to self-govern on renewals.

We also assume occupancy near 97% and turnover nudging up towards 20%. Same home expense growth of 6% to 7.5% assumes property taxes increasing around 8%, and controllable expenses inflating at a mid-single-digits. We should see less of a benefit from the turnover costs being capitalized versus expense as we lap the heavier post-pandemic turns. And we expect turnover expense to be fairly flat. Taken together, this leads us to same home NOI guidance of 6% to 7.5% with stable margins around 68% to 69%. On the acquisition front, we are planning for 2,000 to 4,000 acquisitions this year, including only 400 acquisitions or so in the seasonally low Q1 period and potentially accelerating into the summer. The low-end of our guidance simply assumes seasonal strength in MLS listings until the summer, but no real change in the acquisition environment.

The higher end of the guidance assumes a more significant acceleration of — in the second half of the year, assuming favorable cap rates and available financing rates both around 5.5% to 5.75%. With that, I’ll turn the call over to Gary for final remarks.

Gary Berman: Thank you, Wissam. As we look ahead to another exciting year, we want to emphasize the following messages on slide 19. First, the value of our company is underpinned by our SFR portfolio, which continues to perform extremely well and it’s reflected in a book value per 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 any questions.

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Q&A Session

Operator: Your first question comes from the line of Chandni Luthra from Goldman Sachs. Your line is open.

Chandni Luthra: Hi, good morning. Thank you for taking my question. So, you know, third quarter you talked about seeing a shift from OpEx to CapEx, because more costs were getting capitalized. Now obviously you gave some color on it that a lot of work orders are being done in-house this year or rather more recently. But could you help us understand what happened in fourth quarter, why is it that the total cost to maintain homes was lower? Why was CapEx lower? And how should we think about CapEx going into 2023?

Gary Berman: Kevin, I’m going to turn that over to you.

Kevin Baldridge: Sure. Yes, thank you. Thanks for the question. Yes, we have spent the last six to nine months really focused on cost containment. Our teams out in the field and across the country and we’ve done a number of things. We’ve really tightened our scopes such that we’re able to rain in what the costs are on all the terms to whether we’ve done things like — or before we might see ceilings for instance, on the turn when we didn’t really need to, so we’ve tightened that up. Or we pride ourselves in providing really good service in homes to our residents. And sometimes we had a little bit of scope creep like an HVAC maintenance guy would want to add zones to a house in the HVAC. And we think that’s a little bit overboard, so we’ve cut that back.

So, we’ve turned a number and we’ve really tightened our scopes. We’re also doing more even turns, we’re using in-house people now that we’re not buying quite as much, we’ve repurposed some of our maintenance teams, to help you in-house turns. As well as we’ve increased the number of work orders that we do in-house. We’re now doing 75% of work orders on in-house and we’ve found that when we do work orders ourselves, we’re saving about $400 a job, with conscious about $160 a work order, when we do it in-house for instance $500 to $600 a work order if we bend it out, so that’s lowered our cost as well. And then we’ve also negotiated prices down. We have a price book that we use across the country and we’ve negotiated 670-line items down that we — all of our maintenance techs and supervisors have.

So, between bringing down the prices and doing more work orders in-house, really looking at the scope, we’ve been able to drop our costs or our cash cost the turn, a home dropped from like $5,200 in September to $3,800 in February, that’s a 27% decrease in the cash cost to turn a home. And we’ve also dropped just the maintenance expenses, our cost to maintain homes by doing work orders by about just under 7%, 6.7%. And we hope to bring that down for the rest of the year, so while there is some inflationary pressures out there, mainly with our vendors on labor, we’ve been able to, you know, bring cost ourselves, just by being — by scrutinizing more, we’re doing on scope and our costs.

Chandni Luthra: That’s helpful.

Gary Berman: And Chandni, the only thing I would add to that is that, it’s important to look at everything over a longer period of time. There could be noise in a quarter, it’s always better to look at the full year. If you look at the full-year cost to maintain, which includes both expensed and capitalized items, that was up 14% in the same home portfolio. We think in 2023 that same cost to maintain number will be up about 7%. So still in an inflationary environment, but we are seeing moderation and part of that is because of the scope improvements and cost containment that Kevin talked about.