European Residential REIT T.ERE.UN

RE:CIBC comments on result

[DanielDarden]

incomedreamer11 wrote: Our Conclusion

ERE reported an in-line quarter as the Netherlands rental market, much like here in Canada, continues to remain tight due to a chronic undersupply of affordable housing. And, also similar to Canada, rental rate growth in the Netherlands is somewhat hindered by government policy, tightening a hot rental market as higher interest rates push home ownership further out of reach.
However, with the maximum rental guidance beginning in July 2024 for regulated and liberalized suites announced to be 5.8% and 6.8%, respectively, we believe ERE’s growth will land on the upper end of, if not well above, its initial 3%-5% target, and the REIT’s focus on suite conversion and turnover should drive higher growth. Additionally, the sales of individual suites (unique to the Netherlands market) could be a long-term driver of tremendous value, as well as a potential shift in the European bond market towards a more accommodative stance (i.e., lower rates). As such, we maintain our Outperformer rating and €2.50 NAV estimate; our price target is unchanged, implying a modest discount to our F/X-adjusted NAV estimate.

Key Points Earning Results:
ERE reported Q1/24 diluted FFO per unit of ~€0.04, in line with our estimate. FFO per unit was down ~2.5% Y/Y, largely due to increases in interest and other financing costs, and partially offset by positive increases in SPNOI.

Balance Sheet And Liquidity:
Reported D/GBV was 57.3%, an increase of 400 bps Y/Y, and remains elevated in comparison to international residential peers. Credit metrics also remain within the REIT’s covenant and internal requirements, with a DSCR of 2.4x (1.35x minimum) and interest coverage ratio of 2.9x (1.5x minimum). Total liquidity improved to ~€37MM as a result of suite dispositions being used to partially repay the revolving credit facility. IFRS NAV per unit was €2.89.

Debt And The Rate Environment:
As the interest rate environment continues to stabilize, we are presented with a normalized view of what to expect in terms of debt rolls. ERE’s current weighted average interest rate of 2.2% compares to the most recent fixed-rate refinancing at 4.7% (albeit a commercial mortgage that may not be fully comparable). ERE has ~$60MM of mortgage debt maturing in 2024 at a 2.51% weighted average interest rate that will ostensibly increase its financing costs through 2025. We note that subsequent to quarter-end, the REIT renewed the mortgage financing on one of its commercial properties for a one-year period at an interest rate of 3- month EURBIOR plus a margin of 2.0%.

Distribution Sustainability:
The REIT reported an AFFO payout ratio of ~80.9% based on a €0.12 annual distribution, in line with its long-term payout target of 80%-90%. With a yield of ~7.4%, the REIT remains one of the highest-yielding residential REITs within our coverage universe (vs. ~5% average for the peer group), and continues to be an attractive investment for income-oriented investors, in our view unless otherwise stated 

ERE units are down ~8% year to date vs. the XRE down ~6%. Units trade at a ~35% discount to consensus NAV (vs. ~16% historical discount) and a 2025E P/FFO multiple of 8.9x (vs. ~16x historical average). Present trading values indicate that the REIT is trading at an ~5.75% implied capitalization rate (vs. our utilized 5%) 

My Take: It is difficult to rationalize the discounts given the fundamentals in the Netherlands. Cap rates should improve (decline) and with improving NOI the NAV/ u should benefit from the resulting higher fair market value.