Watch the Apartment REIT – Fund President Q4 2023 Update
Transcript
Ray Punn: [00:00:56]
I’m pleased to provide you with Skyline Apartment REIT’s (Real Estate Investment Trust) update for Q4 2023. Thanks for joining me today, Matt.
Matthew Organ: [00:01:03]
Thanks, Ray.
Ray Punn: [00:01:04]
So, Matt, in the last year and a half to two years, the Bank of Canada has increased interest rates ten times. This is not new news. What was the impact of a higher interest rate environment on Skyline Apartment REIT, specifically in 2023?
Matthew Organ: [00:01:18]
2023 was really about stabilization. We had already been operating in a higher interest rate environment throughout the year. Because the interest rates were up, the overall market sentiment was that cap rates (capitalization rates) would increase, which they did. On the Apartment REIT side, we started the year with an average cap rate of 4.7%. We ended the year with an average cap rate of 4.95%. So, it affects us on a valuation from a multiple of earnings standpoint. But what offsets that is really the absorption of that cap rate increase of the 25 basis points by what we captured in income growth. Our income was up substantially as we turned over units and captured more rent – that mark to market gap that we always talk about. And we were able to absorb that cap rate increase with no negative impact on our Unit Value.
Ray Punn: [00:02:12]
So Matt, you’ve alluded to cap rates, and the cap rate on the Skyline Apartment REIT portfolio going up by roughly 25 basis points in 2023. We’ve seen interest rates go higher than that in the same period. Can you elaborate on that?
Matthew Organ: [00:02:26]
Yeah, certainly. I think the biggest attribute to the Apartment REIT is that when interest rates were at historic lows, we did not adjust our cap rate as aggressively downwards. Knowing that we’re not going to be in that low interest rate environment forever. We knew it would come back. Nobody knew exactly when. No one certainly knew it would come back this fast. But the fact that we didn’t follow a lot of the other REITs out there and be super aggressive and get our caps down in the 4-4.25% range. We ended up at a low average of 4.7%. And a quarter point adjustment upwards at this point to 4.95% is not overly negatively impactful to the REIT at all, because our income growth outpaced that cap rate growth.
Ray Punn: [00:03:14]
Thanks for that, Matt. If the Bank of Canada stalls on interest rate hikes and we see a decline, as some economists are anticipating in 2024, what’s the impact to Skyline Apartment REIT?
Matthew Organ: [00:03:25]
As I just mentioned, we saw the cap rate move this past year, which meant our income needed to move accordingly to hold our same Unit Value. But at this point, I think the common theme is that interest rates likely are at their peak, and assuming interest rates are at their peak, we don’t anticipate any upward pressure on cap rates anymore.
Matthew Organ: [00:03:48]
If we happen to get a couple declines throughout the year, as you mentioned, then we might see some downward pressure on cap rates. But regardless, if our cap rates hold the same throughout 2024, we still have our mark to market rent to capture through unit turnover. And if that’s the case, we’re increasing our income while not adjusting our multiple of earnings, which means that we should have value growth within the Apartment REIT.
Ray Punn: [00:04:11]
Thanks, Matt. We’ve seen some real estate funds impacted in various ways in the current economic environment. How has the Apartment REIT maneuvered itself through this period?
Matthew Organ: [00:04:22]
Yeah, Ray, the difference with the Apartment REIT is interest rates again have a negative impact if you’re in a bunch of long-term fixed leases or you’ve got a lot of vacant space as well. When they’re talking about commercial real estate now in the market, and potential negative impacts to it, the majority of that is referring to office space. Within our fund in the Apartment REIT, we don’t hold any office space unless it’s the office that [Skyline] occupies.
Matthew Organ: [00:04:49]
So, I think where the negative impact comes in, is if you’re in that environment and you’ve got fixed-term leases and they’re not renewing, but you’re having to renew your mortgages at a higher rate. That’s where the potential danger lies. With our REIT, you’ve got a 20% turnover rate. You’re capturing that income as you go up. Yes, you’ve had some incremental interest rate increases along the way, but we’ve had more than enough income to offset that, so it has protected the value of the REIT.
Ray Punn: [00:05:20]
Thanks for sharing that, Matt. One of the questions we get from our investors, and we speak about with our investors very regularly, is around the average interest rate of the overall portfolio for Skyline Apartment REIT, as well as mark to market, or loss to lease. We refer to this very frequently. Can you elaborate a little bit more on both of those?
Matthew Organ: [00:05:39]
Yeah, certainly. So, our average interest rate right now remains at about 3.17%. It’s still well below what market rates are right now. And again, because we lay our mortgages over time, we have very few mortgages, as a portfolio percentage, renewing in any given year. We’ve managed to really keep that low, and we’ve taken some shorter-term mortgages with the anticipation that rates will get better in the future. I know that’s taking a little bit longer than everybody anticipated, but we basically renew and take on the debt that we need to take on to keep moving forward. But we’re strategically watching that to make sure that we can optimize the amount of debt that we have to take at any higher rate at a given point.
Matthew Organ: [00:06:24]
The REIT’s income growth, a lot of it comes from the mark to market turnover as we still see a very high demand for housing. A lot of the condo starts and infrastructure starts have been put on hold when it comes to housing. I know that both provincial and federal governments right now are are trying to put policy in place to really spur housing and get things going again. But the reality is, with the amount of immigration and things that we’ve had, we’re in a housing shortage. As that remains true, our mark to market still remains around $400 a door. So, there’s lots of leeway there to capture income as we turn over those units. And again, with the turnover rate being around 20% per year, there’s lots of income growth in the future for Skyline Apartment REIT.
Ray Punn: [00:07:12]
Thanks for sharing that, Matt. That’s some really good insight for the Apartment REIT. To wrap this up, what does 2024 look like for your REIT?
Matthew Organ: [00:07:18]
So, in 2024, we’re going to continue to do what we’ve always done. We’re looking at acquisitions that are accretive to the REIT. We’re looking at new developments that are accretive to the REIT. We really want to take this time to really prune and reposition some of our older assets. We’ve got opportunity to sell off assets that are not in the most desirable geographical areas – things that we bought, you know, 10-15 years ago, and we’ve got a lot of infill since. We’ve bought more assets across the portfolio, and we’ve got regions built up into scalable sizes.
Matthew Organ: [00:07:54]
So, I think what we’re looking for this year is to continue with that pattern where we’re sort of trimming off some of the older-stock assets, and redeploying those funds into more likely new build or newer assets, things that are more desirable. It will make the portfolio as a whole stronger. From a property management aspect, it will help geographically tighten things up and it just becomes more efficient. It’s going to be a more attractive portfolio overall.
Ray Punn: [00:08:22]
Thanks, Matt, for joining me today. Skyline Apartment REIT is currently open for new investment. If you have any questions, contact Skyline Wealth Management. Thanks for watching.