CIBC commentsOur Conclusion
ERE reported an in-line quarter, highlighted by increased rental demand and expanding NOI margins. As expected, the increased regulatory rental caps announced in July contributed to the rental uplifts on suite renewals and were aided by 20%+ rental increases on turned suites. While the portfolio interest rate remains significantly below its peers (largely a function of the historically lower-rate European debt market), we note that ERE may face material refinancing spreads through 2025 given the current interest rate environment. Nonetheless, the REIT remains on pace to meet or exceed its target rental growth of 3%-4%, and while the ongoing strategic review remains in early discussions, we cannot summarily dismiss the myriad of alternatives the REIT has at its disposal to unlock shareholder value (including the potential of an outright sale of the platform). Trading at a 2024E P/FFO multiple of ~9.6x and a discount to consensus NAV of 40%, we remain Outperformer rated but increase our cap rate 50 bps to 5.00%, and reduce our NAV to €2.35 (from €3.00) and price target to C$3.00 (from C$3.75), implying a discount to our F/X-adjusted NAV. Concurrently, we introduce our 2025 FFO estimates.
Key Points
Earnings Results: ERE reported headline FFO/unit of €0.042, in line with both our and consensus estimates. During the quarter, the REIT reported a fair value loss in investment properties of ~€24.8MM, primarily due to a nominal 5 bps Q/Q increase in the portfolio’s utilized cap rate (+6 bps for the residential portfolio, but a 9 bps decrease in the commercial portfolio).
Balance Sheet And Liquidity: The REIT’s IFRS NAV decreased to €3.05 (vs. €3.15 Q2/23) primarily due to the aforementioned expansion in the utilized cap rate. As a result, D/GBV increased to ~56.4% from 48.7% in Q3/22. While leverage is currently near the limits set forth in the credit facility covenant agreements (<60%), we would anticipate that in the unlikely event a breach were to occur, ERE and its respective lenders would agree on amendments thereto (something we have seen in the past with other REITs that have temporarily bumped up against such covenants). Additionally, the REIT’s DSCR remains strong at 2.5x with liquidity at €27.7MM.
Debt Roll: ERE has ~€79MM of mortgages maturing through 2024 at a weighted average interest rate of ~1.39%. While refinancing risk may be limited in the near term (only ~9% of mortgages due to mature through 2024), we note that the REIT has a larger proportion of maturing debt from 2025 onwards at expiring rates significantly below current refinancing levels (with the most recent renewal done at 4%+). As such, we expect 2025 to be when the REIT may see a material rise in interest expenses given the current interest rate differential alone (but at lower spreads when compared to 2024). Additionally, the REIT reported an increase in interest expenses as a result of increased utilization of its revolving credit facility. On a portfolio level, the REIT currently has a weighted average rate of ~2.07%.
Price Target (Base Case): C$3.00 Our price target is based on a slight discount to our Canadianequivalent net asset value (NAV).
Upside Scenario: C$5.50 We assume that NOI is above our base case expectations, cap rates are lower, and units trade at a premium to NAV.
Downside Scenario: C$1.50 We assume a reduction in NOI as a result of a reduction in occupancy and NOI margin compression.