European Residential REIT T.ERE.UN

Raymond James report - ERES

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4Q23 Results: Higher European Interest Rates Create Near-Term Growth & Asset Sale Headwinds

RECOMMENDATION

European Residential REIT (ERES) reported 4Q23 FFO as expected at €0.04/unit (excluding ~€0.004/unit in non-recurring strategic review costs), unchanged from a year ago.

Positioned to Generate Mid-to-High Single-Digit 2024E Revenue Growth YoY: We believe that ERES could once again exceed its 2024E same-property revenue growth target of +3% to +5% YoY, based on estimated 2024E rent indexation levels for both regulated and liberalized suites, combined with rent growth realized upon suite turnover that averaged +20% in 4Q23. Based on prior year Dutch CPI levels, regulated suite rent indexation in 2024 is expected to be ~4.1% (~33% of suites), while liberalized suite rent indexation is anticipated to be ~5.5% (~67% of suites), suggesting an average blended 2024E rent indexation level of around +5% YoY.

Intends to Accelerate Disposition Activity in 2024 to Maximize Unitholder Value and Reduce Financial Leverage Metrics through Debt Repayment: In 2023, ERES executed 14 town home dispositions for ~€5 mln as part of its vacant rental unit privatization program to owner occupiers. While the REIT did not provide formal guidance, ERES stated on its 4Q23 call that it expects to accelerate its disposition activity of individual rental suites in 2024. ERES will also consider selling wholly-owned MFR properties in the Netherlands that have not been broken up by individual unit privatizations to owner-occupier end users, in the REIT’s efforts to maximize unitholder value, and reduce its financial leverage metrics through the repayment of outstanding debt.

Near-Term Financing Cost Headwinds Expected to Constrain 2024E and 2025E AFFO/unit Growth YoY: We estimate ERES’ debt to EBITDA ratio was ~15x at December, 31, while ERES had ~€79 mln in 2024E debt maturities (~9% of debt) at an average interest rate of ~1.4%, which increases to ~€227 mln in 2025 (~26% of debt) an average interest rate of ~1.9%. If we assume that ERES’ ~€306 bln in maturing in the next 2 years is refinanced at +275 bps higher average interest rates of ~4.50% (equal to ERES’ forecasted interest rate available for upcoming mortgage refinancing on its 4Q23 call), we estimate ERES’ annualized AFFO/unit growth YoY could be impacted by ~€0.036/unit (or ~25% of its 2023 AFFO/unit) in annualized financing cost headwinds.

KEY TAKEAWAY

After concluding its strategic review in December, we believe ERES may not revisit another portfolio sales process until 2H24 at the earliest if market conditions for private market Dutch MFR transactions improve and European interest rates fall. In the meantime, we forecast ERES to generate positive 2024E AFFO/unit growth YoY, as 2024E SP-NOI growth YoY could be partly offset by higher financing costs YoY based on the potential for ERES to face above-average financing costs headwinds as ERES refinances near-term maturing debt at higher market interest rates.

VALUATION

ERES trades at 10.9x 2024E AFFO (F/X adjusted), vs. ~20.3x for its Cdn MFR REIT peers, ~31% below its $3.50 NAV estimate (5.25% cap rate), and yields 7.3% (2024E AFFO payout: ~79%). ERES trades at an implied ~5.9% cap rate or ~€202k/suite. Our new C$2.75 target equals ~12.5x of 2024E AFFO (prior: 13.0x), below its Cdn MFR peer average of ~24.0x due to its below-average unit liquidity.