If a well dressed but somewhat eccentric gentleman offered to sell you a house in a nice neighborhood at 40% off the market price, you would be crazy not to buy it. Mr. Market is doing just that with Minto Apartment REIT (TSX:MI.UN, Financial).
Minto Apartment REIT is an unincorporated, open-ended real estate investment trust in Canada. The REIT owns a portfolio of 32 high-quality income-producing multi-residential rental properties located in Toronto, Ottawa, Montreal, Calgary and Edmonton. It is also in the process of expanding into British Columbia.
The company is sponsored by the Minto Group, a large, privately held real estate company operating in Canada and the U.S., which has about 40% ownership. Minto Apartment REIT also has a strategic alliance agreement with the Minto Group, which provides it with important rights and imposes obligations on the Minto Group that are expected to meaningfully contribute to the company’s growth pipeline.
The initial public offering was in June 2018 at a price of $14.50.
Currently there is strong demand for rental apartments in major Canadian cities. The Canadian government has robust immigration targets set at over 425,000 people annually through 2024. A high proportion of new immigrants settle in the REIT’s key urban markets, driving rental demand. Increased participation in in-person learning from both domestic and foreign students will also drive demand for housing. A record number of temporary study permits were issued in 2021 (466,000) and permits for year-to-date 2022 are 29% higher.
Housing supply remains inelastic to housing demand as population growth is outpacing the housing supply. Canada Mortgage and Housing Corp., a state-owned mortgage insurer, estimates 3.5 million new homes need to be built by 2030 (in addition to the 2.5 million currently forecasted) to restore housing affordability in Canada.
The most acute shortages are in Ontario and British Columbia. Ontario alone forecasts the need for 1.5 million new homes over the next decade in order to keep up with population growth. Housing supply is slow to respond to population changes. In a statement, CMHC Deputy Chief Economist Aled ab Iorwerth said, “There must be a drastic transformation of the housing sector, including government policies and processes, and an ‘all-hands-on-deck’ approach to increasing the supply of housing to meet demand.”
Minto Apartment REIT is currently trading below its net asset value, which should increase or remain stable because of inflation. At the current price of 13.50 Canadian dollars ($9.86), the shares are more than 40% below NAV.
The following chart provides the debt maturity schedule.
Minto's balance sheet is in decent shape with well-balanced equity and debt. Its interest coverage is comfortable at 3.60 (as of June 2022). Interest coverage is defined as operating income divided by interest expense. Interest expense is likely to increase significantly in the years ahead as interest rates are rising.
Source: Simply Wall St.
Source: Bank of Canada
The following chart provides the latest performance metrics. Price-to-funds from operations is less than 10 at current unit prices. The REIT is showing strong gains in rent increases.
The REIT pays a distribution of about 3.5%.
Conclusion
The rapid increase in interest rates by the Bank of Canada has sent the unit prices of REITs crashing, while at the same time rent inflation is rising. The average rent for all property types across Canada in August 2022 was CA$1,959 per month, representing an annual increase of 11.1%. Toronto, one of Minto Apartment REIT's main markets, is one of the worst affected with a two-bedroom apartment going for CA$3,266 in September, up an astounding 24.3% from a year ago.
I think these factors set up an interesting dynamic for apartment REITs like Minto. While their mortgage costs will increase as mortgages renew, rents are exploding higher to more than compensate and demand is expected to exceed supply for years.
At the same time, the REIT is selling for much less than replacement cost. This will set apartment REITs for some solid long-term capital appreciation in the years ahead as we come out of the current recession and Bank of Canada starts to loosen its monetary policy.
