Canadian Apartment Properties Real Estate Investment Trust (CARUN) Earnings Call Transcript

Hello, everyone, and thank you for joining the Canadian Apartment Properties Second Quarter 2025 Results Conference Call. My name is Lucy, and I'll be coordinating your call today. [Operator Instructions]. It is now my pleasure to hand over to your host, Nicole Dolan, Investor Relations to begin. Please go ahead.

Thank you, operator, and good morning, everyone. Before we begin, let me remind everyone that during our conference call this morning, we may include forward-looking statements about expected future events and the financial and operating results of CAPREIT, which are subject to certain risks and uncertainties. We direct your attention to Slide 2 and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Kenney, President and CEO.

Thanks, Nicole, and good morning, everyone. Joining me this morning is Stephen Co, our Chief Financial Officer; and Julian Schonfeldt, our Chief Investment Officer. Let's get started with an update on our achievements so far in 2025, as highlighted on Slide 4. To date, we've sold $274 million of non-core underperforming assets in Canada with the lowest cash returns, and we've completed or committed to approximately $743 million of dispositions in Europe. We've reinvested $165 million of the net proceeds into the acquisition of well-located high-performing, low CapEx Canadian properties, and we've reinvested $187 million into our value-enhancing NCIB program. We've also been extremely focused internally on improving our operational performance. On our Canadian same-property residential portfolio, we've increased occupancies to 98.3% as of period end, across which our average monthly rent grew by 5.2% since June 30, 2024. We've made meaningful strides on the expense side as well, and we've been working hard to contain and reduce controllable expenditures in all areas of the business. These improvements together drove the 40 basis points of expansion in our same-property NOI margin to 66.3% for the second quarter of 2025. Additionally, our balance sheet fundamentals remain best-in-class, with low total debt-to-gross book value ratio of 38.5% as of the current period end. With that initial overview, I will now turn the call over to Julian to expand further on our capital allocation progress.

Thanks, Mark. Turning to Slide 6. You will see all the work we've put in the repositioning of our portfolio, not just this year, but over the course of the past several years. We now have 16% of our portfolio represented by new generation apartments in Canada, up from only 5% as of December 31, 2019. Over the same period, ancillary segments are down from 17% allocation to 5% as of today. Subject to the completion of all committed and pending dispositions in Europe, that exposure would go down to only 2% of our consolidated portfolio, all else held equal. In addition, as announced by European residential REIT, a sale process is launched for the balance of the portfolio with the goal of surfacing its residual value and distributing the proceeds net of wind-up costs to investors. With this progress on our European divestment strategy, we're excited to be moving much closer to our vision of returning to a pure-play Canadian apartment REIT. On Slide 7, we provide a visual snapshot of our portfolio. On the top right, our recently constructed properties come with strong cash flow profiles arising from largely unregulated rents that still contain embedded mark-to-market potential on acquisition, combined with low capital expenditure requirements and operating costs. Their prime highly sought after locations also enhance our geographical diversification and the quality of our resident base with improved affordability characteristics that reduce our political and reputational risks. These properties represent the ideal complement to the stable long-run rent growth trajectory produced by our core legacy assets, which still account for the majority of our total portfolio at 67% today. We're also continuing to dispose of our noncore properties, which generally have the weakest economic returns with regulated rents and low cash flow yields. This repositioning is not only improving the overall quality of the CAPREIT portfolio, but also our income profile and net cash generation. Turning to Slide 8. Our NCIB also remains a key strategic tool allowing us to invest in our own portfolio and earn a stronger return over acquiring comparable assets in the private market today. In 2025, we reinvested $187 million of our own net disposition proceeds to buy back CAPREIT's trust units at a weighted average purchase price of approximately $43 per unit. This represents an average 24% discount to our diluted NAV per unit of $56 as of June 30, 2025, demonstrating the sizable disconnect that we're arbitraging to generate higher earnings for our unitholders. With that, I will now turn over the call to Stephen to expand further on our operational and financial results.

Thanks, Julian. We've been working on recalibrating our rent optimization and vacancy mitigation strategies in response to some short-term market-driven headwinds. And in doing so, we're pleased to report that our residential occupancy in Canada are up again to 98.3% as of June 30, 2025. At the same time, occupied AMR on the total Canadian residential portfolio was up by 7.4% to $1,693 as of June 30, 2025. This not only shows sustained demand for professionally managed rental housing, but it also demonstrates our flexible and proficient operational strategy is working. Turning to Slide 11, with focus on maintaining high occupancies while optimizing rent growth, our same property operating revenues were up by 4.4% for the current quarter. Furthermore, we're pleased to have successfully mitigated the magnitude of cost increases which we were seeing at the outset of the year. And for the 3 months ended June 30, 2025, operating costs as a percentage of operating revenues decreased versus Q2 of 2024. This was in part due to the elimination of the Federal Carbon Tax effective April 1, 2025, which lowered overall utility costs. In addition, repairs and maintenance spending was down, resulting from more competitive procurement practices and the implementation of more rigorous cost control measures while not compromising on quality or service standards. The result was the expansion of our NOI margin by 40 basis points to 66.3% on the same property portfolio. This organic growth contributed to the 2.6% increase in our diluted FFO per unit to $66.1 in the current period. However, it was the accretive trust unit repurchases and cancellations under our NCIB program, which mainly drove this increase in earnings, as well as, to a lesser extent, lower interest expense, partly offset by decreased NOI due to dispositions. Results for the 6 months ended June 30, 2025, are shown on Slide 12. As mentioned, operating costs as a percentage of revenues were up during the first few months of 2025, and our margins are therefore down year-to-date despite our strong performance in the second quarter. Combined with the loss NOI due to disposed properties, partly offset by lower interest expense as well as trust unit buybacks, our diluted FFO per unit was $1.246 for the 6 months ended June 30, 2025. Turning to our financial position as summarized on Slide 13. We continue to boast one of the strongest balance sheets in our peer universe. Our total debt-to-gross book value ratio remains low at 38.5% as of period end, which is down considerably from 41.5% as of June 30, 2024. We take a conservative approach to managing our mortgages with staggered renewals and fixed interest costs, and we actively adjust the maximum borrowing capacity we have available on our acquisition and operating facility in order to reduce financing fees. Most recently, on July 9, 2025, we strategically increased capacity from $200 million to $400 million effective until September 30, 2025, to temporarily fund acquisitions capital investments and for other general trust purposes in anticipation of incoming capital from ERES' expected special cash distribution in September 2025 associated with this upcoming dispositions. This disciplined approach to debt financing provides us with the ability to efficiently manage our portfolio while capitalizing on available market opportunities that maximize value for unitholders. On that note, I will turn the call back over to Mark to wrap up.

Thanks, Stephen. The past few months have been incredibly productive across every facet of the business, and the solid results we achieved during the second quarter of 2025 underscores the success and the merits of our strategy. That strategy is focused on high grading the quality of our Canadian portfolio, improving its operational performance and investing in our value-enhancing NCIB. On top of these initiatives, we have one overarching priority, and that is our cash flow position, as highlighted on Slide 14. All of our strategic objectives are ultimately working together to boost the generation of free cash flow and bring us closer to one-day funding capital expenditures and distributions entirely through our FFO and that, in turn, drives stronger growth in earnings for our unitholders. We are well on our way to achieving that in the near future, and we have never had a better team in place to make it happen. With that, on Slide 15, I would like to thank all of our unitholders for their ongoing support, as we continue working to enhance the future of our residents, our people and our investors. We would now be pleased to take your questions.

The first question comes from Fred Blondeau of Green Street.

When looking at the new supply. How do you compare Toronto, Montreal, Vancouver over the next call, over the next 18 months or so? Is it fair to say that it looks like the GTA is a bit more new when compared to Montreal and Vancouver looks a bit more risky. Is that fair to say?

Yes, it's fair. I'll give us some CAPREIT context, Fred. The problem is the most acute in Toronto, but CAPREIT is the least affected, I'll say, by that supply in Toronto, because it's primarily in the Toronto core and primarily a preponderance of bachelor and one-bedroom condominiums, which we're not competing with CAPREIT's portfolio is extremely suburban, large suites and built-in affordability. I would say, secondly, we're seeing obviously the effected supply in Vancouver, where it's affecting us a little bit more because that's been a primary focus zone for CAPREIT's new construction investment program and high grading, and we've been able to obviously buy some exceptional assets, albeit not in the core, but still there's competition there. And then I would probably say Montreal ranked third. But that's a market for us where, again, we've invested in high-graded assets but have a nice blend of legacy assets, and we're -- if anything, we're quite bullish on the future there. So I think you've got a good read on the market, but that's where CAPREIT sits today.

That's totally fair. Last one from me. How long do you think landlords will have to provide incentives on new builds in those three markets, Toronto, Montreal and Vancouver?

Well, I don't think there's a playbook. At the end of the day, we are finally getting our heads around this very complicated market. And I would just start off, Fred, by saying, we are -- we are in a housing crisis, but we are now more in an affordability crisis, okay? And the real driver of weakness in the housing market is not immigration in our humble opinion. It's got more to do with unemployment and wage issues out there. So this was finding the fine balances. So incentives, they are still being used in the marketplace, and we have to use them where we're competing. Albeit not as much, but people are reacting more to the sticker price of the unit. And when you hit that right affordability spot, we're finding a very, very deep market in Canada. So it's really now more about an overall affordability crisis in Canada more than it is a supply issue and the impact of immigration. We're just not seeing that.

So what would be your scenario on this affordability crisis? Do you think it will still prevail in '26? Or you think it's longer or shorter?

I think the effects of tariffs are not fully absorbed into Canadian economy. So I don't -- I'm not an economist, but we're watching closely. That's not a tailwind. I would characterize that as a headwind. But I think our portfolio is exceptionally well positioned to deal with any sort of economic downturn. We all know that apartments thrived in economic downturns. So that would be a tailwind. I think that right now, it's -- the market has down stability. There's good leasing activity in the summer. We think that's probably a sign of people being concerned about the housing market, and that will tilt in our favor. But I would expect a sort of steady state as we go into -- at least the next 6 months. Looking at any further than that is pretty much guessing.

The next question comes from Mike Markidis of BMO.

Could not help but notice that your incentive activity just in terms of an aggregate dollar amount declined fairly meaningfully quarter-over-quarter, at least versus Q1. And I was wondering if you could just comment, was that a change in strength in the market? Or was it just a change in terms of how you were adjusting your actual face rents or quarter-over-quarter?

That is a great question. And we have been kind of going back to the last question, trying to find that affordability sweet spot. Like we're getting definite feedback and incentives on their own are not effective fully. And we are in situations where there's -- housing providers offering multiple month's free rent to get traffic in the door and we're -- return volume with late one free month rent, but not in all properties. And our focus is definitely around finding occupancy stability as we go into the winter months. But the trend is positive. Like we are definitely seeing a more active market than we did in Q4 and even in Q1. And feeling relatively optimistic about the stability of the market.

Yes. And I'll just say that in terms of -- when we looked at the incentives, there are targeted buildings. And we're obviously trying to be competitive within the region or in that area. And those incentives are -- have come down dramatically. Obviously, we have adjusted the market rent as well to reflect that, so which is why you also see occupancy coming up. So yes, they're mainly in select target buildings across the nation, but they're coming down compared to Q1.

And then just last one for me before I turn it back. I guess for -- in August now, it seems like you feel like things have stabilized. I'm just giving -- trying to get a sense of I guess, the early review on Q3, just how the new leasing spreads have been projecting thus far.

Yes. I would -- again, the stability is the underscored we're using here. I would just remind like we have this issue of coated leases that are still bleeding off, and those COVID leases, we're seeing neutral to negative spreads and seeing extremely encouraging spreads on the non-COVID leases. But using the word, I think, stable would be the direction I would give you, Mike. I'm pleasantly surprised. We weren't sure what the effects of unemployment were going to actually be. And I think it's being offset by this concern around the state of the housing market, which is the typical first few innings of a housing shift. You see people starting to go into rental as a safe haven. So that part is good.

The next question comes from Jonathan Kelcher of TD Cowen.

Just to stay with that on the lift on turnover is at 4.6% in the quarter. Is that -- when you say stable? Is it like -- so we should sort of think about 4% to 5% on turns over the next few quarters?

Yes. That would be a fair assumption based on our comments.

Okay. Fair enough. And then secondly, just a little modeling one, but there has been a lot of noise in your G&A the last few quarters. How should we think about a run rate going forward there?

Yes, Jonathan. So obviously, there has been some structural changes within the organization. We're looking at our teams, and we're trying to optimize to make sure that it's set up for success. And when you look at G&A numbers, what we've done in the financials or the MD&A is we separated between trust expenses and re-org costs. Those re-org cost are what we consider nonrecurring. And hopefully, we won't see that going forward. Obviously, we're still going through our structural -- our structural review. But we don't hope to see that going forward, at least for the next -- Q4 onwards. But if you're looking at for modeling purposes, I would say what we've provided as a percentage of our operating revenues. I think that 5% around 5% is a good modeling for going forward.

CAPREIT has become a smaller unit count entity, albeit the rents are higher in the new construction buildings. But we are really digging internally. Julian has talked about the capital allocation change and to match that we have to optimize our overhead costs, and we're being very mindful looking forward into like this new stable period of slightly lower mark-to-market rents. We're going to get the overheads exactly optimized to have great stable state going forward. But we've made a lot of progress to date. There is not much more to do. But yes, we're very excited about the improvements have been made there.

The next question comes from Sairam Srinivas of Cormark Securities.

Mark, just going back to your comments on incentives, affordability. How do you overlay that on to the acquisition strategy and the opportunities you're seeing out there for acquisitions and the trade-off between long-term opportunity and short-term costs over there?

Yes, it's a great question. So the team does -- we do a lot of work and due diligence around market rents. And in many cases, it is hard to determine because you may have a new construction asset surrounded by no real purpose-built competition. But then we use the data comparisons that we have in every market and get comfortable with where things can be at. We, of course, look at the incentives that are being offered in the market and put that also into place. And in many cases, the investment team will come to an arrangement in the short term on what incentives are required. Julian, maybe you can give some color on that?

I mean one overarching point that I'll mention, and I know Mark and Stephen and myself have mentioned this, but oftentimes, these types of buildings are actually in the most affordable ones because the income of the tenants in there can be quite a bit higher. So the rent increases you put on their -- stretch their affordability a lot less. I'll also say that when we -- like we look across the whole spectrum of potential acquisition opportunities, but even looking at some of the acquisitions that we have done this year so far. I look at the [ Beacon, McLaren, Mondev ] those were -- those buildings were all buildings with rents in the $3 per square foot range, which still quite affordable, I'd say, for new construction. And many of those actually had embedded loss to leases or gaps between in-place and market rents. So we are very tactical about trying to avoid getting the micro suites that are in the $6 per foot range. It doesn't mean we don't look at everything, but again, we think that we've got good properties that are affordable to the tenants in them, in AAA locations as well as a couple of small legacy buildings that we bought in Vancouver in just exceptional, exceptional AAA locations with rents that are also quite affordable.

Maybe just quickly on, I think earlier in June, I guess, you guys put out a small release on potential developments that you could probably see or densification in the portfolio. Is that something that could be a part of the capital allocation program?

Well, I'm going to let Julian talk to that, but we were so, so excited about this. And I'm really glad you brought this up because I really will take every opportunity I can to kind of better describe what's going on there. Of course, development almost has like a negative connotation to it, especially in Toronto. But what the investment team and development team put together here is really exceptional, where we did this with no parking cost because we're utilizing the parking in an adjacent building. No development fees, no land cost, wood free. And we're doing it with political support. We have the Mayor of Mississauga applauding us for adding new supply. We're proud to add supply for families in Canada, and it's panning out to a very, very attractive CAPREIT. So I don't want to steal all the thunder on this, but Julian can give some more color around how incredibly positive that announcement really was.

Yes. It's great. We think we can build that all in, all costs total for, call it, around $500 per square foot, which you can't get anything new in the GTA for that cost. And it's for all those reasons, Mark mentioned, there's an incredible amount of incentives and synergies in there. We're going to be doing it at an incredible NOI margin because We don't really have any staff that we need to use. We can use them from the existing high-rise tower. You don't really have incremental landscaping and snow removal, those types of costs for sub-metering everything. So I want to say like development is not our primary business. We're not converting to a developer. We're not going to be a REIT where you're going to look at it and say, wow, there's that huge percentage of assets under development. This is small tuck-in stuff that's incredibly accretive. And by the way, for this low-rise wood frame stuff, it's very quick and a very small amount of capital in there. So given all those synergies and incentives, there's enough margin that it'd be really hard to get in trouble with that. And it helps renew the GTA portfolio because the point that there's mentioned is there isn't really much purpose-built rental to acquire in GTA because it was all historically done as condos. There's a little bit that was done as purpose-built rental by some owners that were long-term owners. And so again, small, fast, low-cost, tons of margin just a nice, neat tuck-in.

And a wonderful cash flowing property, like getting back to the cash flow story. This -- as Julian said, brings renewal to the portfolio. We will not be able to buy new construction assets that were built with pre-COVID contracts forever. We were always noting that, that new construction opportunity would be a moment in time in the marketplace. And but we've got our eyes to better cash flow. We've got our eyes on these AAA locations. And at the end of the day, we are fixated on renewing the quality of the portfolio, so cash flow improvements are here to stay for the long term. So it marries in very nicely to the overall arching strategy, but it really is for CAPREIT, all of the AAA locations, well cash flowing properties and high grading the quality.

And that was really exciting, Dave. And just to clarify, that $500 per square feet numbers, excluding all the incentives and synergies you're seeing there?

The $500 -- the approximate estimated cost. All the hard costs, all the soft costs, financing costs divided by the leasable square feet. So it's all inclusive. So again, we couldn't acquire anywhere near that cost. And we're estimating it's going to be north of 6% cap rate on our cost. And by the way, that's with rents that we're seeing today are sub-$3 per foot. So we think we're being pretty conservative in a lot of our estimates to get to that. We're not the type of folks that are going to do development for a 25 or 50 basis point spread on current cap rate. We're doing this because there's a really huge margin and just tons of reasons. And again, it's very modest in size, but great opportunity.

And it might be helpful, if Julian, you just comment on what purpose-built rental concrete is costing developers there today on a per square foot basis for context in the Toronto problem.

Yes. Well, actually I was just on the phone with a pretty prominent developer a couple of days ago, and we were trading numbers on a few things. But he was -- he was telling me that one of the projects they're underwriting right now without any land value in there, the cost when dividing all the costs by the leasable square-foot for concrete was in the $900 per square foot. And again, that was without profit, or without land value, which, to be honest, you'd be building at loss with a huge time line, a lot of risk and a ton of capital. And so for us, we view that as completely unviable and something we don't like. But this stuff, again, 12 to 18-month construction period, around $500 per square foot and very little risk.

The next question comes from Kyle Stanley of Desjardins.

Maybe just going back to your optimization commentary from a bit earlier. Now that you're approaching the end on the ERES value maximization program. It seems like a lot of the heavy lifting on the capital recycling front in Canada is finished. Where does management focus efforts next to find that next leg up or that extra value?

Yes. It's ruthless internal optimization. At the end of the day, on all fronts, like it's -- it's the team. We have the best -- like I said in the commentary, the best team that we've had that I can remember. And operational excellence is the focus of everyday conversation. Tensions are extremely high internally because we are digging very, very deep. And there's just feels like the cap rate of many years ago, quite frankly. We're digging right in and looking at everything, everything is under review. And I think while we're seeing the results, but there's -- we're very excited about how our cost structure is looking going forward. And every day is revealing more good news in terms of opportunities that we can harvest.

Okay. That makes sense. Maybe just looking at the performance in your Southwestern Ontario portfolio. It did look quite strong in the quarter with same property up 13%. Anything specific you can call out there that's contributing?

Yes. That was -- there was some lower R&M cost that was like, I guess, we're really, I guess, kind of talking to what Mark was saying, operational excellence, looking at our contracts and looking at our costs, make cost containment and even looking at procurement effectiveness strategies. We were able to manage some of the R&M costs, while we did have higher operating revenues. Partly, there were some AGIs that were included in there, that was helpful. So that drove the performance in Q2.

Okay. And then just the last one. Can you comment on maybe how active you expect to be on the transaction front in the second half? And more specifically, has the level of acquisition opportunity? Has that changed at all maybe over the last quarter or 2? Are you seeing any changes on seller pricing expectations just given maybe this softer market outlook that we've been talking about?