Reit's NOI up in Q1/23, but Interest Expense Is Too
Research Report

During Q1/23, European Residential REIT (ERE.UN:TSE) outperformed operationally, but higher interest expense offset net operating income (NOI) growth, reported Echelon Capital Markets analyst David Chrystal in a May 11 research note.

Given the quarterly results, which were as anticipated, Chrystal wrote that Echelon revised some of its estimates on this Canadian owner of residential units in the Netherlands. Ultimately, Echelon lowered its target price on the REIT to CA$4.50 per share from CA$4.90.

Attractive Investment Opportunity

However, Echelon expects the REIT will continue delivering consistent organic NOI growth, Chrystal highlighted. At its current share price of about CA$3.09, he added, the company is still trading "at a steep net asset value (NAV) discount (38%) versus the Canadian multifamily peer group at (13%)."

Therefore, the European Residential REIT is a compelling investment opportunity, offering a roughly 50% return.

Accordingly, it is a Buy.

NOI Growth Continues

The REIT's portfolio performed solidly during Q1/23, posting "organic NOI growth supported by strong rent lifts on turnover, modest lifts on renewal and elevated occupancy," Chrystal wrote.

Specifically, same-property NOI rose 5.2%, and revenue increased 5.4% during Q1/23.

"Slightly higher rental caps in 2023 (3.1% on regulated, 4.1% on liberalized) should allow the REIT to continue to deliver year-over-year rent growth in excess of its 3–4% target range," wrote Chrystal.

Interest Expense a Headwind

As for costs, operating expenses in Q1/23 were up 6.3%, notable among them persisting higher interest. Consequently, funds from operations per unit (FFO/unit) were down by about 6% over FFO/unit in Q1/22.

If the REIT's interest expense remains where it is, in the high 4% range for long-term mortgage debt, Chrystal purported, it will continue impacting the company's NOI growth "over the next few years."

Asset Divestment Possible

Chrystal reported that the REIT's management, at this time, is looking into and considering all possible ways to maximize shareholder value.

"Given the significant NAV discount and elevated interest rate environment, we could see asset dispositions, with proceeds earmarked for debt reduction," Chrystal wrote but added such a transaction would take time to carry out and to have an effect.

Changes to Estimates

To reflect the company's Q1/23 results, Echelon revised some of its estimates on European Residential REIT.

Given the higher interest expense, the wealth management firm lowered, by 1% each, its FFO and adjusted funds from operations forecasts on the REIT for the full year of 2023. It also slightly raised the cap rate it uses to determine NV to 4.25% from 4.15%.

As a result, NAV stayed about the same.

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Disclosures for Echelon Capital Markets, European Residential REIT, May 11, 2023

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ANALYST CERTIFICATION
Company: European Residential REIT | ERE.UN-TSX

I, David Chrystal, hereby certify that the views expressed in this report accurately reflect my personal views about the subject securities or issuers. I also certify that I have not, am not, and will not receive, directly or indirectly, compensation in exchange for expressing the specific recommendations or views in this report.

IMPORTANT DISCLOSURES

Echelon Wealth Partners Inc. and/or one or more entities affiliated with Echelon Wealth Partners Inc. beneficially own common shares (or any other class of common equity securities) of this issuer which constitutes more than 1% of the presently issued and outstanding shares of the issuer.