CALGARY, Feb. 14, 2017 /CNW/ – Mainstreet Equity Corp. ("Mainstreet" or the "Corporation), an add-value, mid-market consolidator of apartments in Western Canada, is announcing its operating and financial results for the three months ended December 31, 2016.
Bob Dhillon, Founder and Chief Executive Officer of Mainstreet, said, "We have certainly faced financial challenges over the past 18 months due to ongoing economic uncertainty. However, as we enter into 2017, Mainstreet management is cautiously optimistic that we could be seeing early indications of gradual market recovery." Dhillon added, "Throughout this ongoing uncertainty, Mainstreet has continued to pursue its 100% organic, non-dilutive growth model which has continued to serve the company and our shareholders well."
Despite encouraging financial highlights, Mainstreet continued to face challenges in Q1 2017 due to broader economic forces. Net operating income ("NOI") from operations was down 6% YTD, while funds from operations ("FFO") was down 20% (excluding one time pay-out penalties of $1.9 million).
This was due to slower economic activity in our Alberta and Saskatchewan markets, resulting in increased vacancies, lower rental rates and increased concessions to tenants. Alberta was especially impacted by uncertain economic conditions.
However, lower returns in the Prairie provinces were partially offset by our Vancouver/Lower Mainland assets, which comprises 30% of our portfolio. The region steadily grew in performance over the year, maintaining a vacancy rate below 1% and NOI growth of 7% YTD. We believe there will be substantial potential for further increases in market rental rates in the region, which could raise our NOI and FFO in future quarters.
As we begin fiscal year 2017, Mainstreet continues to pursue a series of strategic plans that were crafted over 12 months ago in response to macro economic challenges in some of our core markets. These strategies included acquiring assets at low cost; refinancing significant portions of our pre-maturity debts at low interest rates; and continuing to buy back our own shares under our normal course issuer bid ("NCIB") on an opportunistic basis, as we believe those shares to be trading significantly below their true net asset value ("NAV"). Below, we outline the highly beneficial results of those strategies.
FINANCIAL HIGHLIGHTS FOR Q1 2017:
- For the first time since Q2 2015—a time when the economic recessions in Alberta and Saskatchewan were intensifying—Mainstreet saw an uptick in same-asset revenues in Q1 2017, rising to $23.2 million from $22.8 million in Q4 2016. This occurred despite Q1 typically being a season of low activity in the rental market.
- We continued to demonstrate the effectiveness of our 100% organic, non-dilutive growth model by growing our portfolio without increasing share capital. Since its inception Mainstreet's portfolio has surpassed 10,000 units (we now have a total 10,181 units) while our total number of shares has remained at 8.8 million – the same as when Mainstreet began trading on the TSX in 2000.
- Refinanced $50.1 million in pre-maturity debt with an average interest rate of 5.24% into mostly 10-year long-term CMHC-insured mortgage loans for $101.5 million at an average interest rate of 2.44% and financed four clear title assets with a 10-year long-term CMHC-insured mortgage loans for $39.8 million at an interest rate of 2.34%. These financings resulted in an annualized interest savings of $1.5 million, totalling $15 million for 10 years and raised $89 million in additional funds after payout penalties.
- We continue to grow through strategic and opportunistic acquisitions in our core markets. Year to day, we required 303 residential units for a total consideration of $28.3 million-an average cost of $93,000 per unit.
- Maintained our sizeable year-to-date estimated liquidity position of $151 million, including a cash balance of $45 million, to pursue further potential growth opportunities.
RESULTS
In Q1 2017, FFO excluding one-time payout penalties decreased 20% to $6.2 million, compared with $7.8 million in Q1 2016. FFO excluding one-time payout penalties per basic share decreased 9% to $0.70, compared with $0.77 in Q1 2016. Revenues increased 2% to $25.8 million, compared with $25.4 million in Q1 2016; this came alongside a 3% fall in same asset rental revenues to $24.7 million, from $25.4 million in Q1 2016. NOI decreased 6% to $15.7 million, while falling 9% to $15.1 million on a same asset basis. Operating margins dropped to 61% compared to 66% in Q1 2016.
The same asset vacancy rate increased year-over-year to 8.2% from 7.8% in Q1 2016. The overall Q1 2017 vacancy rate, which includes vacant units as apartments undergo stabilization, increased year-over-year to 9.7% from 7.8% in Q1 2016. As of the year end date, 799 units, or 8% of the portfolio, remained in the stabilization process.
During Q1 2017, Mainstreet refinanced $50.1 million of pre-maturity debts with an average interest rate of 5.24% into 10-year, long-term CMHC-insured mortgage loans totalling $101.5 million at an average rate of interest of 2.44%. We also financed 4 clear-title asset properties for $39.8 million at an average rate of interest of 2.34%. Together, this refinancing activity raised approximately $89 million in additional funds after a pay-out penalty of $1.9 million, and resulted in an annualized savings in interest expense of approximately $1.5 million, totalling 15 million for 10 years.
Subsequent to the Q1 2017, Mainstreet has obtained approval to refinance an additional $10 million of pre-matured debts with an average rate of interest of 4.95% into 10-year, long-term CMHC-insured mortgage loans for $19 million at an average rate of interest of 2.78%. Mainstreet also obtained approval for a $28 million, 10-year CMHC-insured mortgage on 8 clear titled assets at an estimated average interest rate of 2.9%. Together, this subsequent refinancing activity raised approximately $30 million in additional funds after a pay-out penalty of $185,000, and resulted in an annualized savings in interest expense of approximately $218,000, totalling $2.2 million for 10 years.
Management is well aware that the one-time pay-out penalty of $2.2 million, paid in the first and second quarters of financial year 2017, would have adverse effect on the Corporation's financial performance in the respective periods. However, with total interest savings of over $17.2 million in the next 10 years, the raising of over $ 126 million of low cost capital for potential future acquisitions and share buy backs; and reduction of the Corporation's overall interest risk exposure, Management expects that the long-term benefits will far outweigh the short-term effect on financial performance of the Corporation.
CHALLENGES
Ongoing volatility of petroleum, natural gas and other commodity prices continues to create economic uncertainty in some of our core markets. This uncertainty is compounded by the introduction of the Alberta carbon tax, which was rolled out in January 2017. The economy-wide tax is structured in a way that charges the owners of buildings while offering rebates to tenants, which in turn raises our heating and electrical costs. Mainstreet currently has its electricity costs in Alberta contractually locked in at a fixed rate until April 2018. However, our internal research suggests that the provincial carbon tax will add additional costs in fiscal 2018 of roughly $8.8 per unit. Additionally, increase in rent concessions, tenant turnover and bad debts also created additional cost pressures in Q1 2017.
Mainstreet's vacancy rate was above average over the quarter. This was largely a result of a high level of vacancy across the Prairie provinces, coupled with the $78 million in acquisitions the Corporation has completed over the past 15 months. While we view this vacancy rate as high (9.7%), we see this as a short-term trend as we continue to undergo our stabilization process.
Negative macro economic forces have likewise caused significant short positions on Mainstreet stock. We believe this is partly responsible for our share price trading well below NAV. As of December 31, 2016, the short position on Mainstreet totaled 752,600 shares.
Broadly speaking, the impact of lower commodity prices and market volatility is difficult to measure in precise terms. However, we believe the current situation also creates a series of opportunities that are discussed at greater length in the Outlook section below.
OUTLOOK
Mainstreet saw its same-asset revenues, vacancy rate and funds from operations excluding utility cost increase in Q1 2017 compared with Q4 2016. This marked a positive quarterly movement for the first time in six quarters. The uptick occurred despite that Q1, historically, is a winter season of low activity in the rental market.
We believe this revenue increase could be an early indication of market stabilization in the Alberta and Saskatchewan markets. Ideally, this is a signal that we are nearing the tail end of the downward curve in revenues on a same-asset basis. However, we maintain a cautious perspective in this regard, as the macro economic picture in those markets remains uncertain. In addition, the performance of our BC portfolio, which accounts for approximately 30% of Mainstreet's portfolio, maintained an average vacancy rate below 1%. We anticipate that rental revenues from our BC portfolio will continue to grow through rent increases and further improvements in occupancy rates.
We see several key indicators of positive movement in the Alberta and Saskatchewan markets. According to recent Canadian census data, Alberta's population grew 11.6% between 2011 and 2016—the highest rate in the country and more than twice the national average. The population growth over the period was even higher than it was from 2006 to 2011, when Alberta's economic situation was, on balance, healthier. Saskatchewan's population growth was the second highest in the country at 6.3%. Overall, the 2016 census marked the first time in Canadian history that the three Prairie provinces (Alberta, Saskatchewan and Manitoba) had the highest population growth in the country.
Mainstreet views this demographic shift as a highly positive indicator for our Alberta and Saskatchewan markets in the long term. We see this trend continuing in future, provided economic activity continues to improve. In Alberta, the provincial population is expected to grow by 1.6% in 2017 and by 1.7% in 2018, according to CMHC data. Saskatchewan's population also continues to grow, and is expected to rise by 1.3% in 2017 and 2018.
Steady in-migration levels come as the rental market begins to show signs of absorption. During recent years of high economic growth, there was a rapid build out of condominiums, particularly in Alberta, which began coming onto the market in mid-2015. We believe this led to a lot of condominium units being owned by investors with the intention for the higher-end rental market. The economic recession and the lower in-migration level, which resulted in an oversupply of condominium rental units, created a spillover effect and caused an increase in vacancy rate in the apartment rental market. However, Mainstreet believes this oversupply will continue to absorb through fiscal 2017 and 2018.
Additionally, we expect the recent relaxation of Canadian immigration policies to attract a number of foreign workers, foreign students, immigrants and refugees to some of our core regions—most of whom are likely to enter the rental market.
With immigration numbers anticipated to rise, we also believe stricter requirements on CMHC-insured mortgages implemented by the federal government in 2016 are favourable to the rental market. The new legislation may serve to deter first-time homebuyers in particular, who could be more exposed to higher interest rates and therefore more likely to rent rather than buy. This has the additional benefit of helping to absorb the aforementioned excess capacity in the condominium market.
Moreover, Mainstreet is well positioned to capitalize on this rental market growth. In times of economic uncertainty, renters tend to favour middle market prices as they delay major investments like new homes. Our price point average rental rate between $900 and $1,000 perfectly aligns with that mid-market demand.
We also believe that the oil and gas industry in Western Canada is showing indications of improvement early in 2017. US President Donald Trump signed an executive order in January 2017 to move ahead with the Keystone XL pipeline, which is seen as a highly positive development for the sector. The decision is complemented by the Canadian government's approval of two major oil pipelines in October 2016. The approval of the three pipelines is expected to aid in attracting investment to Canada's oil and gas industry.
In addition, the global oil cartel known as OPEC agreed to collectively cut back their oil production in November 2016, potentially putting a floor on prices. Oil prices in early 2017 have been increased significantly above their 2016 lows, and the consensus among commodity analysts is that prices will continue to rise in 2017 and 2018.
Mainstreet believes these broader market conditions create substantial opportunities for growth, and we are pushing the reset button on our approach to acquisitions. The current environment of low interest rates and slower GDP growth makes this an ideal time to expand our portfolio on an opportunistic basis.
Lastly, we expect to benefit from lower costs and availability of labour. The easing of labour market pressure provides us with an opportunity to bulk up on senior and middle management personnel at a cost that would have been impossible when economic activity was at its peak.
RUNWAY ON EXISTING PORTFOLIO
- Closing the NOI gap: Over Q1 2017, 10% of the Mainstreet portfolio remained unstabilized, which contributed to higher vacancy rates. While this is a normal part of the Mainstreet business model, our continual work in renovating and improving properties before releasing them back to the market provides, in our opinion, potential to improve NOI and FFO performance. This inherent challenge in our business model is further increased by recent acquisitions, which causes higher rates of unstabilized properties that affect our NOI and FFO.
- Renegotiating long-term debt: Interest rates, which account for Mainstreet's single largest expense, are among the lowest we have ever experienced. We expect to cut these expenses further by refinancing our remaining $10 million in mortgage loans maturing in 2017 and debts maturing in 2018 at an expected average interest rate that will be much lower than the current average rate of 5.2%.
- Buying back shares at discount: We believe MEQ shares continue to trade well below their NAV. Additionally, the current discount, in our opinion, does not fully account for numerous intangible assets, including Mainstreet's diversified asset base and non-dilutive growth model. We will therefore continue to buy back our own shares on an opportunistic basis under our NCIB.
- Leveraging our ample liquidity: Finally, we maintain a substantial YTD liquidity position that will allow us to capitalize on opportunities for acquisitions and the repurchasing of shares. We anticipate that our estimated YTD liquidity of $151 million will translate into roughly $ 600 million in acquisition opportunities based on a leverage level of 75%.
Forward-Looking Information
Certain statements contained herein constitute "forward-looking statements" as such term is used in applicable Canadian securities laws. These statements relate to analysis and other information based on forecasts of future results, estimates of amounts not yet determinable and assumptions of management. In particular, statements concerning estimates related to future acquisitions, dispositions and capital expenditures, increase or reduction of vacancy rates, increase or decrease of rental rates and rental revenue, future income and profitability, timing of refinancing of debt and completion, timing and costs of renovations, increased or decreased funds from operations and cash flow, the Corporation's liquidity and financial capacity, improved rental conditions, future environmental impact the Corporation's goals and the steps it will take to achieve them the Corporation's anticipated funding sources to meet various operating and capital obligations and other factors and events described in this document should be viewed as forward-looking statements to the extent that they involve estimates thereof. Any statements that express or involve discussions with respect to predictions, expectations, beliefs, plans, projections, objectives, assumptions of future events or performance (often, but not always, using such words or phrases as "expects" or "does not expect", "is expected", "anticipates" or "does not anticipate", "plans", "estimates" or "intends", or stating that certain actions, events or results "may", "could", "would", "might" or "will" be taken, occur or be achieved) are not statements of historical fact and should be viewed as forward-looking statements.
Such forward-looking statements are not guarantees of future events or performance and by their nature involve known and unknown risks, uncertainties and other factors, including those risks described in this Annual Information Form under the heading "Risk Factors", that may cause the actual results, performance or achievements of the Corporation to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks and other factors include, among others, costs and timing of the development of existing properties, availability of capital to fund stabilization programs, other issues associated with the real estate industry including availability but without limitation of labour and costs of renovations, fluctuations in vacancy rates, unoccupied units during renovations, rent control, fluctuations in utility and energy costs, credit risks of tenants, fluctuations in interest rates and availability of capital, and other such business risks as discussed herein. Material factors or assumptions that were applied in drawing a conclusion or making an estimate set out in the forward-looking statements include, among others, the rental environment compared to several years ago, relatively stable interest costs, access to equity and debt capital markets to fund (at acceptable costs) and the availability of purchase opportunities for growth in Canada. Although the Corporation has attempted to identify important factors that could cause actual actions, events or results to differ materially from those described in forward-looking statements, other factors may cause actions, events or results to be different than anticipated, estimated or intended. There can be no assurance that such statements will prove to be accurate as actual results and future events could vary or differ materially from those anticipated in such forward-looking statements. Accordingly, readers should not place undue reliance on forward-looking statements contained herein.
Forward-looking statements are based on Management's beliefs, estimates and opinions on the date the statements are made, and the Corporation undertakes no obligation to update forward-looking statements if these beliefs, estimates and opinions should change except as required by applicable securities laws or as otherwise described therein.
Certain information set out herein may be considered as "financial outlook" within the meaning of applicable securities laws. The purpose of this financial outlook is to provide readers with disclosure regarding the Corporations reasonable expectations as to the anticipated results of its proposed business activities for the periods indicated. Readers are cautioned that the financial outlook may not be appropriate for other purposes.
SOURCE Mainstreet Equity Corporation
