European Residential REIT T.ERE.UN

RBC

[retiredcf]

Thanks jj. 
Their current and upside scenario targets are $5.25 and $6.50. GLTA

September 14, 2022
European Residential REIT Property tour takeaways

European Residential REIT (“ERES”) hosted a two-day investor tour in the Netherlands. In total, we viewed 8 properties in the greater Amsterdam, Rotterdam and The Hague regions, representing a good sample of ERES’ portfolio. The investor tour also included a brief presentation by Cushman and Wakefield. Below are our key takeaways.

Key points:
Fundamentals – an all too familiar story... housing market remains tight. For sale home supply has steadily declined since 2011 and today, the average time to sale is 24 days. National home prices have continued to increase to an average of €448K (+9% y/y) and there is a high need for new housing supply at a time when regulatory risks (and higher construction costs, labour shortages etc..) have resulted in planning permits dropping off meaningfully. Market rent for liberalized suites in Netherlands were up 12% y/y in Q2/22 to €184.2 per sqm per year. As previously reported by ERES, its turnover rent spread has steadily accelerated to +22% in Q2/22 although turnover rate has also steadily declined to 10%.

Regulatory changes: No clarity yet but there is an acknowledgement by the Housing Minister that his comments have resulted in decline in permits. Recall: In May 2022, the Dutch Housing Minister indicated plans to expand rent control to the ‘mid-market’ effective Jan 2024. Since then, there has not been any further comments. There appears to be an acknowledgement on his part that his comments have impacted construction which could further exacerbate the housing issue. As such, the Minister is consulting with the industry with a view to come up with a solution that, perhaps, balances him not walking back his words while at the same time, not resulting in a market with a challenged business model that does not support new supply. Management expects news potentially before end of this year, perhaps as early as next week, as noted by Cushman and Wakefield (C&W). ERES’ key message was that notwithstanding this uncertainty, the Dutch rental market has always dealt with regulatory changes and in the last 40 years (1980-2020), regardless of these changes, market rent growth has averaged a healthy 4.1% per annum.

Asset pricing: +5 to +50bps Gross Initial Yield increase. C&W noted a +5 to +50 bps increase in gross yields in Q2/22. C&W also showed a few recent transactions of newly built assets in The Hague, Rotterdam and Utrecht that suggest that despite the movement, gross initial yields remain fairly low at 3.4-3.7% (or estimated going in cap rates of ~2.6% to 2.9%). Our NAV estimate of €3.65 is based on a blended cap rate of 3.9%.

An interesting plan B or at the very least, a value buffer: ERES noted that all of its assets are individually titled and as such, lend themselves to be sold in the owner-occupier market (this is unique relative to the Canadian apartment industry). Given the tight housing market, the owner- occupier value could be higher than the value of the unit as a rental product to the tune of 10-15% (IFRS value is based on the latter). This is especially the case for its single family homes which represent ~1/3 of ERES’ portfolio. Indeed, we visited a townhouse where we estimate the owner-occupier value would imply a cap rate of <3%. While this inherent value is more of an academic exercise today, unitholders may be comforted that to the extent that there is a significant adverse development in the rental regulatory regime, there is an option (although we think unlikely in the near term) to sell its portfolio to end users.

Assets and operation observations:

• There are ~65 people in the local team and the portfolio is run in a decentralized model in that collection, leasing, property management all work together within a specific region (vs departmental silos). This allows for employee mobility, engagement but is more difficult to scale.

• We saw a good cross section of newer built assets and older assets in gentrifying neighbourhoods. Unlike the North American market, buildings are not well amenitized. At the same time, the ability to pass through the majority of common area costs (& utilities) to the tenants, by way of service charges, is a big positive in today’s high inflation environment. Our sense is that ERES/CAPREIT’s North American’s perspective is incrementally adding value to the asset.

• Return on capital investment is fairly healthy (12-15%), especially for those units that have been converted to liberalized from regulated. Given the market rent being achieved on improved units, we think that there is likely room for further upside in turnover spreads.