InterRent Real Estate Investment Trust T.IIP.UN

RBC

[retiredcf]

Their upside scenario target is $20.00. GLTA

November 1, 2023

InterRent REIT
In line; Current revenue growth looks sustainable

Outperform

TSX: IIP.UN; CAD 11.76

Price Target CAD 16.00 ↓ 17.00

Our View: InterRent REIT (“IIP”) reported FFO/unit of $0.15, +4.3% y/y, in line with RBC/consensus of $0.15/$0.15. Strong NOI growth of +10.5% translated to +4.3% FFO growth given +19% in interest expense. However, 2024 should see better conversion of NOI growth to FFO growth (estimated +12%). We believe ~7% revenue growth is sustainable in the near term given high MTM opportunity. Current price implies 4.8% cap rate, ~9% unlevered IRR, an attractive spread to bonds. Maintain OP.

Key points:

Solid double digit SP NOI growth of +10.5% (SP-Rev +8.2%; SP-Exp +3.7%): Revenue growth was primarily rate-driven with SP-Occupancy at 95.2% (-20 bps q/q, -40bps y/y) and SP-AMR of $1,566, +2.8% q/q, +7.3% y/y. Montreal & Ottawa saw 6-7% rent growth; others +8%. Rents may have been pushed a little too hard in certain markets. On the cost side, opex and taxes were up 4-5%; utilities down 2% from lower natural gas costs. SP-NOI margin expanded to 67.6%, +140bps y/y.

Outlook – we believe that current revenue growth of ~7% is sustainable in
the near term given the high mark-to-market rent opportunity, which IIP
conservatively estimates at 30%+, but that we believe is closer to 40%+. IIP
noted that fall leasing activity has been robust. One potential small blemish
is the recent announcement by Quebec government to increase tuition
fees for out-of-province students. While it is hard to quantify the impact (IIP expects immaterial impact), we estimate that ~20% of IIP’s Quebec  portfolio is in close proximity to universities or ~4% of its total portfolio.

Capital allocation - more office conversion: IIP acquired a 25% interest in an Ottawa office conversion ($4.4M). This follows success at Slayte (84% leased, +24 pts q/q). 5% distribution hike is not a surprise, a small nominal amount and sustains its long track record of increases, although we wonder about alternate use, e.g, debt paydown or development funding.

We expect better conversion rate from NOI growth to FFO growth in ‘24: Interest expense growth is less of a headwind in ‘24E due to base effects and $220M of debt maturing at 5.33%, of which 35% is variable-rate mortgages being refinanced with CMHC debt by early Q1.

Valuation: IIP trades at a p/suite of ~$285K, implied cap rate of 4.8% on F12M NOI. Given our expectation for NOI growth (average last 8 quarters = 11%), we estimate the current price implies an unlevered IRR of 9%, 500 bps higher than 10-year GOC bond yield (vs. 425 bps LTA for CDN multi-res). Our NAV of $14.50 (-3%) is based on a cap rate of 4.4% (+15bps) vs. IFRS BV/unit of $17.62 (-3%), based on a cap rate of 4.22% (+15bps). IIP noted that thawing of frozen investment market could potentially bring another 5-15 bps further cap rate expansion if rates stay where they are. Our price target of $16 ($-1) is based on a parity to forward NAV.