MEQ Mainstreet Equity Corp

CALGARY, AB, May 10, 2022 /CNW/ - In Q2 2022, Mainstreet achieved its second consecutive quarter of double-digit, year-over-year growth across its three most important operating metrics, with rental revenues and net operating income ("NOI") increasing 14%, and funds from operations ("FFO") growing 12%. 

Bob Dhillon, Founder, President & CEO of Mainstreet, said, "Our latest results speak to the success of our countercyclical growth strategy, where we have continued to generate shareholder returns despite ongoing market volatility." He added, "As we enter this new inflationary period, we see more opportunities to add value. In particular, our core strategy of acquiring properties at well below replacement costs continues to form the foundation of our business model, and will serve us well in a higher interest rate environment."

We attribute these positive results in large part to the success of our long-term, value-add growth strategy, which we executed by accelerating acquisitions and improving stabilization cycle times during the COVID-19 pandemic. We also view these results as a result of improving market fundamentals, including the return of immigrants and foreign students to Canada, higher inter-provincial migration levels, and a sharp economic rebound in some of our core markets due to soaring oil prices. Furthermore, Mainstreet sees a significant opportunity to build on this momentum as we enter what has typically been our high rental seasons in Q3 and Q4. Current economic circumstances provide fertile ground for Mainstreet to continue pursuing its countercyclical growth strategy, where we have historically taken advantage of market volatility by expanding and diversifying our portfolio on an opportunistic basis. Our current liquidity position of $240 million offers ample firepower to acquire new assets at competitive costs.

Meanwhile, we believe that ongoing inflationary pressures will make it increasingly difficult for many low and middle-income Canadians to own a home. In that context, Mainstreet will continue to fulfill our role as a crucial provider of quality affordable housing, offering inner-city living at modest prices. To maximize our position in the market, Mainstreet intends to aggressively reposition units during the second half of fiscal 2022 to reduce our sizable NOI gap, continuing our 22-year legacy of driving shareholder value. 

Despite a promising operating environment for Mainstreet, inflation and subsequent Bank of Canada interest rate hikes continue to create economic uncertainty. Inflation raises the cost of everything from labour to materials and, chiefly, increases Mainstreet's cost of debt (our largest expense alongside acquisitions). The bank's overnight rate has increased 100 basis points since our last Message to Shareholders, with more hikes still anticipated in the future, Mainstreet has mitigated this challenge to the extent possible by locking in the majority of its debt for long terms at lower rates. Please see "Outlook" below.

At the same time, global supply-chain constraints have also significantly increased the cost of goods and services. Costs for materials are rising, which increases Mainstreet's costs in completing renovations and maintenance. Canada's labour market also remains tight, with job vacancies reaching a near-record of 915,500 positions in late 2021 (Statistics Canada). This has raised Mainstreet's labour costs and made hiring more challenging. 

Major fixed expenses, such as property taxes, insurance, and utilities have increased in line with government policy. Carbon taxes, which place the financial burden on property owners, are scheduled to increase on an annual basis. 

Even as the current economic climate creates some operational uncertainties, Mainstreet sees substantial opportunity in fiscal 2022 and 2023 to further diversify and expand its portfolio and acquire assets at competitive prices. In 2021, Mainstreet diversified into the Winnipeg, Vancouver Lower Mainland and Interior British Columbia markets. In the years since the beginning of the pandemic in early 2020, we have acquired $340 million in new assets. We expect that higher interest rates will reduce the number of able buyers in the market, in turn offering Mainstreet additional opportunities to pursue its 100% organic, non-dilutive growth model by purchasing undervalued properties. 

In upcoming quarters, we anticipate that interest rates are likely to rise quickly as the Bank of Canada has signaled additional hikes in the remainder of the current fiscal year. To guard against these increases, our management team has ensured that the vast majority of Mainstreet debt is set at long-term fixed rates. Currently, 99% of our total mortgage debt is fixed at an average CMHC-insured interest rate of 2.51%, with an average maturing period of 7.1 years (see chart).

Management believes that sharp interest rate increases may further cause market price corrections, which would provide unique opportunities for Mainstreet to purchase more apartment buildings at adjusted risk. Furthermore, management believes that inflationary periods tend to be transitory in nature. Should interest rates once again fall sometime in the coming years, Mainstreet will benefit not only from more competitive acquisition costs, but also lower interest expenses (resulting in higher FFO) on refinancing after stabilization.

Current market conditions also create opportunities to extract additional value out of its existing assets. Mainstreet's vacancy rates were 8.3% in Q2 2022 and are currently 7.4%, largely due to our large volume of unstabilized acquisitions in the last 18 months. Looking ahead, we see major opportunity to reposition units in order to lower that vacancy rate and reduce our NOI gap. In Q2 2022, 2,086 units out of a total 15,609 (13% of our portfolio) remain unstabilized, creating favourable conditions to boost operating income after stabilization. 

Meanwhile, Mainstreet's strong Western Canadian asset base, reaching from British Columbia to Manitoba, will continue to underpin our future growth. We expect that our Alberta and Saskatchewan assets will continue to benefit from high commodity prices. Oil benchmarks recently surpassed US$100 per barrel for the first time since pre-2015, partly due to a supply shock caused by the Russia-Ukraine conflict. Oil revenues in Alberta have surged to the point that the province is now back in budget surplus. Similarly, tech firms in the province attracted a record $561 million in venture capital funding in 2021, according to the Canadian Venture Capital & Private Equity Association (CVCA), suggesting Alberta is gradually diversifying its economy. In-migration into the province of Alberta reached 12,940 in Q4 2021, among its highest level in recent years (Alberta Economic Dashboard). We believe these trends will continue to create favorable operating conditions for Mainstreet in the second half of 2022. 

We expect our Vancouver/Lower Mainland market will continue to drive corporate performance, as vacancies remain among the lowest in the country while rental rates remain near the highest. British Columbia has become central to Mainstreet's portfolio, accounting for 33% of our IFRS value. With an average monthly mark-to-market gap of $445 per suite per month, 96% of our customers in the region are below the average market rent. That translates into approximately $16 million in NOI growth potential after closing the mark-to-market gap, according to Mainstreet's internal estimates.

As border restrictions are eventually fully lifted, we believe that immigration levels will increase and more foreign students will enter Canada, two demographics that form a substantial portion of Mainstreet's client base. The Canadian government's goal to attract 1.2 million immigrants over three years should be broadly supportive of that trend. We expect that an increase in foreign students will be particularly supportive of our Edmonton market, where Mainstreet has situated itself as a central provider of student housing. 

Lastly, a chronic housing shortage will continue to make owning a home unaffordable for average Canadians. This reinforces Mainstreet's belief that inner-city, workforce affordable rental housing will remain an essential and safe asset class in Canada. In 2019, 44.5% of the working Canadian population earned an income of $49,999 or less, according to Statista Research Department. Mainstreet's rental rate, with a price-point averaging between $900 and $1,000, is perfectly positioned to attract those seeking affordable and quality homes in today's market.

Inflation, as with all aspects of the economy, will drive up the cost of building new rental properties. We believe this only deepens Mainstreet's leading position in the rental market, given that we have built our portfolio through the acquisition of existing properties at prices that are well below the replacement cost of such properties (or, the cost of developing new rental properties). That market dynamic is central to the value-added proposition Mainstreet offers, supported by strong market fundamentals like rising levels of immigration and our ongoing stabilization process. Further, higher costs to build rental properties is supportive of broader rental market dynamics, as it restricts new supply.

Our management team has worked hard to safeguard Mainstreet from rising interest rates by locking in the majority of our debt at low fixed rate long term mortgages (see Challenges section). While we anticipate that interest rate hikes will plateau in the medium term, we also believe that we will benefit even if inflationary trends persist, given that we have taken full advantage of the last few years of low interest rates, allowing us to expand our portfolio at highly competitive costs.

Mainstreet, as a provider of affordable housing for middle-income Canadians, is deeply committed to maintaining the highest standards of social responsibility. Amid the ongoing Ukraine crisis, for example, that has meant taking in refugees displaced by conflict. During the pandemic, that commitment meant waiving rental payments for struggling tenants; delaying rent increases; halting evictions; and allocating additional financial resources toward safety provisions to support our customers. We believe the social benefits of such actions far outweigh any short-term financial losses. 

Ever since Mainstreet listed on the TSX in 2000, diversity has been a key pillar in who we are. Our belief in the positive benefits of minority inclusion has persisted for decades, providing Mainstreet with a highly dynamic and unified workforce.

1. Pursuing our 100% organic, non-dilutive growth model: Using our strong potential liquidity position, estimated at $240 million for fiscal 2022 (including $25 million cash-on-hand, a $130-million line of credit and potential financing of clear title assets), we believe there is significant opportunity to continue acquiring underperforming assets at attractive valuations.
2. Boosting NOI: As of Q2 2022, 13% of the Mainstreet portfolio was going through the stabilization process. Once stabilized, we remain confident same-asset revenue, vacancy rate, NOI and FFO will be meaningfully improved. We are cautiously optimistic that we can boost cash flow in coming quarters. In the B.C. market alone, we estimate that the potential upside for NOI growth is approximately $16 million, which mainly represents leveraging our mark-to-market gaps.
3. Buying back shares at a discount: We believe MEQ shares continue to trade below their true NAV, and that ongoing macroeconomic volatility could intensify that trend. We will therefore continue to buy back our own common shares on an opportunistic basis under our normal course issuer bid.

TSX: MEQ
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SOURCE Mainstreet Equity Corporation