European Residential REIT T.ERE.UN

RBC 2

[retiredcf]

Their upside scenario target is $6.50. GLTA

May 6, 2021

European Residential REIT 
Mr. Market vs. the regulators

Our view: After weighing the impact of recently introduced rent control measures, growing mark-to-market potential, and European Residential REIT's ("ERES") Q1 results, our constructive outlook remains little changed. While there are many moving parts behind the scenes, we continue to see the REIT's regulatory know-how, its strong sponsorship by Canadian Apartment Properties REIT ("CAPREIT"), and the persistent housing shortage in the Netherlands as supportive, and largely offsetting, factors. Net/net, we continue to see significant nominal and attractive risk-adjusted return potential and trim our price target by $0.25 to $5.25 solely on FX.

Key points:

A strong start to 2021. ERES delivered an in-line Q1 print, underpinned by residential SP-Revenue growth of 4.7% vs. 3.9% in 2020 and 5.0% in 2019 (excl. pass-through items). That said, recent regulatory changes did not take effect until May 1st. Post Q1, our 2021–22E FFOPU increase by 2%/1% yet remain unchanged on a rounded basis at €0.14 and €0.15. These estimates reflect growth of 6%/3% and a 2019A–22E CAGR of 3%. We trim our NAVPU by 2% to €3.25 (-€0.05) on working capital changes, with our 1Y forward NAVPU of €3.45 (unchanged) reflecting growth of 5%.

Potential rent growth largely unchanged despite regulatory changes. As detailed herein, the Dutch government has passed new legislation to limit rent increases for sitting tenants in liberalized suites at CPI+1.0% for the next three years. This is in addition to the previously announced one- year "rent freeze" for regulated suites. While we expect the combined impact will shave ~90 bps from top-line growth in 2021, we see a ~50 bps offset from growing releasing spreads (e.g., 14% in Q1/21 vs. 7% in 2019). Management believes this will enable the REIT to deliver 2021 top-line growth at the low-end of its target 3–4% range (unchanged), with 3–5% SP- NOI growth supported by up to ~80 bps of potential margin expansion.

To us, the new ERES growth algorithm looks a lot like the one in Ontario before the pandemic. Taking a step back, rent increases of 1–2% for sitting tenants, a low- to mid-teens mark-to-market opportunity, and suite turnover of 13–14% yield a similar growth algorithm to GTA-focused apartment REITs prior to the pandemic (see Exhibit 1 herein). While the path to above-average rent growth has changed, we see the acute housing shortage in the Netherlands supporting continued growth in market rents. A greater portion of which, we believe, will simply be captured on suite turnover instead of through regulated, annual increases going forward.

Residentiele consolidator met groei plannen (link). In our eyes, ERES remains a residential consolidator with big plans (and a big opportunity). While the pandemic has slowed the REIT's external growth, we believe this will pick up as ERES leverages its ample liquidity, CAPREIT relationship, and eventually re-gains its cost of capital. Overall, we believe ERES's units continue to trade at an unwarranted 11% discount to NAV vs. European peers at -7% and ERES's pre-pandemic premium of 4–8%.