European Residential REIT T.ERE.UN

Scotia comments on result

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Printing Solid Rent Growth But Incremental Regulatory Challenges in Front of Us

OUR TAKE: Neutral. Our target is slightly reduced to $5.00 (-$0.25) and largely in line with our NAVPU of $5.00 (-$0.15). Our NAV is now based on 3.60% residential cap rate (+10bp q/q) vs IFRS cap rate of 3.38%. Our NAV of $5.00 is conservative relative to IFRS NAVPU of $5.77. Our NAV is based on EUR/CAD of 1.30 which has come down meaningfully from 1.50 last year. ERE is trading at an 37% discount to IFRS NAV and a 34% discount to our 1-yr fwd NAV estimate of $5.45 (Exhibit 2). We expect an AFFOPU CAGR of 7.9% in 21A-23E. Our AFFO estimates are largely unchanged despite new debt financing of €118M at a higher 3.29% p.a. interest rate.

Printing solid rent growth but incremental regulatory challenges in front of us: Q2 SP rent growth was 4.2% y/y, ahead of management guidance of 3% to 4%. Rent growth in H2/22-H1/23 could be higher than Q2/22 as rental indexation has increased to 2.95% effective July 1, 2022 (from 1.5% in the previous year). We forecast rent growth of 4.2% in H2/22 (vs 4% in H1/22) and 4.3% y/y for full year 2023 based on current legislation. However, management mentioned that additional regulation is expected, which could impact mid-rental segment. More details expected later this year.

KEY POINTS

Cost of financing has ticked up meaningfully: ERES recently secured €118M new mortgage financing at fixed interest rate of 3.29% p.a. for a six-year term. This compares to low-to-mid 1% cost of financing secured last year. Management mentioned that investment spreads have come down but still look reasonable especially in the context of an uptick in CPI and higher market rent growth. Management is likely to go cautious on acquisitions in H2/22 after completing €85.4M of acquisitions in H1/22. Leverage at 48.8% as of Q2 – target is to keep it under 50% in the near-term. Details on recent acquisitions are in Exhibit 4 and portfolio build-out in Exhibit 5.

Once again regulatory discussion dominated the conf call: Operating metrics were good with SP NOI growth of 3.9% y/y in Q2 (slightly below last quarter level). Occupancy remained strong through the pandemic and is currently at 98.4% (down 20bp q/q). Most vacant units are under renovation and should add to the rent growth profile. Rent growth on turnovers has been in the 15%-20% range in the last few quarters. Despite good numbers, discussion around potential mid-market rent regulation dominated the conf call. We understand that the Ministry is working on an additional mid-market regulation, which could modernize the “points” calculation and could stretch the regulations to include mid-market up to €1,000 or up to €1,250. Also, encouraging people to increase the energy efficiency measures. We expect more information later this year, after which the legislative process will start, which should lead to approval in parliament.