Mainstreet Equity Corporation is a Canadian real estate corporation, engages in the acquisition, divestiture, value-enhancement, and management of multi-family residential properties primarily in Western Canada. The company owns a portfolio of mid-market rental apartment buildings in Surrey & Abbotsford, BC; Calgary, Edmonton & Lethbridge, Alberta; as well as Regina & Saskatoon, Saskatchewan.
Simply put, the first quarter results are among the best year-over-year improvements in Mainstreet history, with a significant increase in both funds from operations (“FFO”) and net operating income (“NOI”), rising 51% and 27%, respectively. Rental revenues also grew 21%.
We see these achievements as a direct result of what Management believes is a gradually improving economy in our core markets, as well as the long-term, countercyclical strategy that our Management team adopted more than four years ago in anticipation of the economic downturn. This strategy included aggressively acquiring underperforming properties during the period of economic slowdown in some of our core markets; strengthening our internal resources to more rapidly convert residential units; and locking in the majority of our debt at low interest rates, which both reduces interest expenses (Mainstreet’s single-largest expense), and provides sufficient low-cost capital to fund future growth.
Bob Dhillon, Founder and Chief Executive Officer of Mainstreet, said, “Our first quarter of 2019 provides a promising window into the success of Mainstreet’s value-add growth strategy, which has continued to create real value for our shareholders.” He added, “This Q1 provides us substantial momentum to build upon our model of acquiring new assets at low cost, and expanding our portfolio in a non-dilutive manner as we enter a new year.”
Management believes our Q1 results prove the gradual success of this value-add strategy, we acquired 421 new units, and are approved to refinance another $45.5 million worth of long-term, CMHC-insured mortgages at low interest rates ($20.5 million was funded in this quarter) and stabilized 116 units. This follows on the gains we achieved in fiscal 2018, when the estimated market value of our investment portfolio reached nearly $2 billion after acquiring a record 1,300 units, and converting a record 705 units. We boosted NOI and FFO despite an accelerated rate of acquisitions over the past three years, which typically increases vacancy rates and lowers operating income. This further proved our ability to rapidly stabilize units, which allows us to wring maximum value from existing assets. Same-asset vacancy rates dropped across our portfolio in Q1, down to 6.0%, from 11.3% a year earlier. Our operating margin on a same-asset basis, meanwhile, increased to 64%, up from 60% last year.
- Growth: Achieved 100% organic, non-dilutive growth by acquiring 421 residential units for approximately $50 million over the quarter. These acquisitions follow the highest-ever rate of acquisitions in Mainstreet history in 2018, when the Corporation added $150 million in new asset value.
- Operation: NOI and FFO increased sharply, by 51% and 27% respectively despite an accelerated rate of unstabilized acquisitions over the past coupe of years which typically increases vacancy rates and lowers both NOI and FFO
- Occupancy: Improved our occupancy rate to 93.3% in Q1 2019, above the 88.9% one year earlier.
- Technological investment: Continued to seek out cost-effective investments and embrace new technology, including a five-year, $2-$3 million investment in a leading software technology from Yardi System Inc., which will automate our systems and, we believe, sharply improve our operational efficiencies.
- Refinancing: Raised $20.5 million in 10-year, long-term CMHC-insured mortgages at an average interest rate of 3.26% to fund our acquisition and growth.
- Mortgage: Locked in 91% of our mortgage portfolio as CMHC-insured mortgages at an average interest rate of 2.98% with an average maturity period of 6 years, reducing our exposure to interest rate risks.
- Liquidity: Managed to maintain liquidity level over $120 million, even after approximately $150 million in acquisitions over the year.
Rental revenues in Q1 2019 increased 21% to $32.6 million, compared with $27.1 million in Q1 2018; this came alongside an 8% increase in same-asset rental revenues to $29.0 million, from $26.7 million in Q1 2018. NOI increased 27% to $20.8 million, and increased 15% to $18.6 million on a same-asset basis. FFO including one-time item of $292,000 increased 51% to $9.6 million, compared with $6.3 million in Q1 2018. FFO per basic share also increased 51% to $1.09, compared with $0.72 in 2018.
Operating margins from operations increased to 64% from 61% in Q1 2018; margins also improved on a same-asset basis to 64%, up from 60% a year earlier. The Q1 2019 vacancy rate on a same-asset basis dropped to 6.0%, compared with 11.3% one year earlier. Overall vacancy decreased to 6.7%, down from 11.1% in 2018, due in part to Mainstreet’s fast-paced stabilization of assets over the year, and despite a record number of acquisitions in 2018 that would typically drive up vacancy rates.
For more detailed analysis of Mainstreet operating results for Q1 2019, please refer to the sections titled “Funds from Operations” and “Rental Operations” in our MD&A.
Despite recent improvements, negative macroeconomic forces remain our biggest challenge. This uncertainty has been compounded in recent years by higher operating costs in some of our core markets, particularly Alberta, due to carbon taxes, interest rate increases, higher property taxes, higher minimum wages, and higher expenses tied to the conversion of stabilizing apartment units.
Higher operating costs come as interest rates could continue to rise through 2019 and possibly 2020, increasing the cost of Mainstreet’s future debt.
Lower international petroleum and natural gas commodity prices have also persisted. Prices for West Texas Intermediate, a US oil benchmark, slumped at the end of 2018, but recovered to above US$50 per barrel as of January 20, 2019, while Western Canada Select, the price obtained by many Alberta producers for oil, slipped to below US$10 per barrel in December, 2018. That remains well below prices of roughly US$65 and US$40, respectively one year earlier.
This low-price environment was particularly acute for oil producers in Western Canada around the end of 2018, when they suffered the steepest discounts for their product in decades. That discount was a direct result of Canada’s inability to build new export pipelines in recent years, which Mainstreet believes has damaged confidence in the national regulatory regime. This regulatory and legal failure could lead to a broader cooling off in the investment climate in Canada, Management believes, and continue to hamper our business competitiveness relative to other jurisdictions.
Management also believes negative macro-economic forces could likewise have caused short positions in respect of the trading of Mainstreet common stock. We believe this is partly responsible for our share price continuing to trade well below what we believe to be its true net asset value.
The new fiscal year offers unique opportunities to build upon our 2018 improvements and continue our countercyclical growth strategy. In particular, we see the potential for more opportunistic acquisitions in 2019, supported by a slower-than-expected rise in interest rates, immigration growth, and stricter stress tests for mortgages that are expected to push more people into the rental market. Similar to last year, we will also continue our aggressive stabilization strategy, which should further grow our top-line revenues and NOI, particularly amid a gradually recovering economy.
Those efforts should be supported by a gradual macroeconomic improvement in our core markets, which has led to promising migration numbers. In-migration into Alberta was 14,514 in Q3 2018, a 47.5% increase from Q3 2017, and the highest overall level in four years (Government of Alberta). In-migration into Saskatchewan was 2,079 in Q3 2017, a 14.6% drop year-over-year. The overall population in both Alberta and Saskatchewan has continued to grow in the year ended June 30, 2018, rising 1.49% and 0.98%, respectively.
Higher population growth comes alongside improved labour numbers in the Prairie Provinces. Alberta’s unemployment rate dropped to 6.4% in December 2018, down from 7.0% one year earlier. Saskatchewan unemployment was 5.6%, down from 6.5% in December 2017 (Statistics Canada).
Mainstreet believes these positive indicators have helped return the rental market closer to balance. Rental markets have been oversupplied in recent years following a rapid build out of condominiums during years of high economic growth, which then spilled over into the broader rental space. However, we see this trend gradually reversing as new tenants continue to absorb that oversupply.
We also believe that broader market volatility in turn creates areas of opportunity for Mainstreet. In our opinion, mid-market rental rate, with a price-point average between $900 and $1,000, is perfectly positioned to attract would-be renters in today’s market. Renters tend to favour mid-market prices during times of economic uncertainty as they defer major investments like new homes. We believe we are uniquely positioned to capture foreign workers, students and new migrants within this lower bracket.
Management believes this trend among first-time buyers (who usually come out of the overall rental pool) are underscored by tighter borrowing requirements under the Office of the Superintendent of Financial Institutions, announced in 2017, which will make it more difficult for first-time homebuyers to secure financing. We see this trend as generally supportive of the rental market. The Bank of Canada estimates the new rules could disqualify as much as 10% of new buyers every year.
RUNWAY ON EXISTING PORTFOLIO
- Pursuing our 100% organic, non-dilutive growth model: Using our strong potential liquidity position of approximately $120 million, we believe there is significant opportunity to continue acquiring new assets at low cost. We also believe Mainstreet’s business strategy will allow us to continue to boost NOI and FFO while improving quality of living standards for middle class Canadians.
- Closing the NOI gap: In Q1 2019, 17% of the Mainstreet portfolio was going through the stabilization process, even as we achieved lower overall vacancy rates compared to 2018. This inherent challenge in our business model is further increased by our record-high volume of acquisitions in recent years, which causes higher rates of unstabilized properties that decreases our NOI, FFO and margins. However, we plan to focus our efforts on stabilizing units through 2019.
- Buying back common shares at a discount to NAV: We believe MEQ shares continue to trade well below their NAV. We will therefore continue to buy back our own common shares on an opportunistic basis under our normal course issuer bid.
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
For further information: Bob Dhillon, President and CEO, (403) 215-6070, www.mainst.biz, www.sedar.com