Our Q1/22 Upgrade note 2022 catalysts = (1) improved rent spreads (check) (2) NCIB activity (not yet); and (3) Ontario election and Federal policy clarity (not yet). Q1/22 new lease spreads of 10.2% vs. 8.6% q/q (Exhibit 3) are likely moving to mid-teens (i.e., pre-pandemic) on return to Canada and Office. Despite strong SSREV offset by rising heating expenses, we believe the worst is behind us with CAR 99%-hedged in terms of price (at $2.18/GJ; Exhibit 4). We sensed CAR is looking to redeploy equity from asset sales (at sub-2% cap rates) into the NCIB (implied cap rate of 4.4%); it is not keen on higher leverage (to fund NCIB). We ask you to review the many charts in our upgrade note for support, but net-net, we think CAR is a “Growth” play (Exhibit 5) being treated as a “Value” stock (Exhibit 6) for the first time in 10 years, an attractive combo. CAR has traded at a 15%+ discount to our NAV only 6% of the time since 2003 (only during the GFC), returning an avg. 19% NTM total return when it does (Exhibit 7). CAR multiple is down 12% during COVID vs. +2% for CAD REIT sector (Exhibit 8). Our upgrade risks were: Q1/22 cost pressure (check), adverse Ontario election (feels Ok; June 2), private cap rate expansion of 50bp+ (we don’t see it on 3%+ CAD Real GDP growth), and Federal government policy review (we expect in October/November).
Q1/22 Highlights & Developments
OUR TAKE: Mixed. Recurring FFOPU was $0.555 vs. $0.58 q/q and $0.554 y/y, below our $0.58 and consensus $0.60 (range = $0.56-$0.77) and = +0.1% y/y (Q4/21 = -1.6% y/y; 2021A = +1.9%). The entire shortfall was from higher operating costs (-$0.04) and G&A (-$0.01), offset by a $0.02 beat in revenue.
Total SPNOI fell 1.7% y/y (Q4/21 = -2.0%; 2021A = +1.0%); SPREV/SPEXP were +2.3%/+9.6% (Q4/21 = +1.2%/+7.6%), driving 250bp SP Margin erosion y/y (Q4/21 = -190bp y/y; 2021A = -10bp). The "other expenses" and utilities were +12% y/y (Q4 = +12% y/y; 2021A = +110bp) and +13.6% y/y. Bad debt = 0.7% of revenue (Q4/21 = 0.8%). For example, Quebec SPNOI fell 10% y/y on 16% cost increase.
A more modest $20M FV gain ($0.43/un; ~0.9% of closing price) vs. $568M FV gain q/q ($3.27/un; ~6%), as fee-simple cap rate was +2bp q/q to 3.59% (Q4 = -7bp). CAR IFRS NAVPU = $59.43 vs. $59.78 q/q.
Net-net, we felt the market would focus more on SSREV trends than SSNOI for CAD Apartment REITs in Q1, including CAR. We’re pleased with the SSREV gains and think SSEXP trends should moderate (particularly R&M given 2 elevated quarters; Q1/22 and Q4/21).
Rent growth is improving. We’re pleased to see Canadian new lease spreads climb north of 10% (10.2%) vs. 8.6% q/q (2021A = +5.9%), while the renewal spread was 1.3% for combined 1.9% rent uptick (Q4 = 1.4%/4.2%; 2021A = 1.8%/2.5%). The lower uptick is due to CAR issuing lease renewal notices to 44% of entire tenant base, including all Ontario/B.C. leases effective Jan 1, 22 this year due to prior-year rent freeze; Q2 onwards should be much better mathematically. SP occupied apartment rent and occupancy was +2.1% and +90bp y/y to $1,323/suite and 98.6%, with rent growth improving vs. Q4 growth (Q4 = +1.9%/+70bp). On a q/q basis, occupancy was +50bp to 98.6% (Q4 = +20bp), while avg. rent was +0.9% (Q4 = +0.5%). Stand-out q/q rent growth markets = SW Ontario (+1.7%) and B.C. (+1.6%). AGIs were completed on only 271 suites, with 8,300 applications o/s, while new incentives = $546k vs. $1.9M y/y and $1.6M of amortization during Q1.
IFRS fee simple cap rate was +2bp q/q to 3.59% (Q4 = -7bp) with our total est. IFRS cap rate moving to 3.72% (Q4 = 3.70%); vs. our 3.86% NAV cap rate. Apartments and MHCs cap rates were +2bp and +1bp to 3.62% and 5.67%, respectively (Q4 = -3bp/-10bp). GTA was +1bp to 3.26% (Q4 = +1bp). We think some of the 2bp q/q jump was due to capital recycling, while the rest was due to a 17bp jump in Alberta to 4.34%.
Active acquisition quarter; we think market would prefer less external growth for the time being. CAR acquired $389M in Canada to date (~$455k/suite) and $31M in the Netherlands (at 100% share); total 2021A acquisitions = $1.05B. Given the wide trading discounts to NAV (i.e., investors expecting higher private cap rates), we feel the market is less enthused about external growth today and perhaps more interested in liquidity preservation/unit re-purchases (CAR did not acquire any since its announced NCIB on March 21), something perhaps CAR acknowledged in the Letter to Unitholders (i.e., increase use of dispositions).
Liquidity fell $165M q/q to $293M (Q4 = +$76M to $458M), incl. $64M in cash & $229M of lines. Reported Debt/GBV was +50bp q/q to 37.6% (Q4 = +110bp to 36.1%). CAR refinanced $553M of debt YTD at an avg. ~3.1% (in-line with expiring of 3.1%), netting $293M of proceeds.