MEQ Mainstreet Equity Corp

CALGARY, AB, July 26, 2022 /CNW/ - In Q3, Mainstreet achieved its third consecutive quarter of double-digit, year-over-year growth across its three most important operating metrics, with rental revenues increasing 14%, net operating income ("NOI") increasing 13%, and funds from operations ("FFO") growing 12%. 

Bob Dhillon, Founder and Chief Executive Officer of Mainstreet, said, "These latest results are more evidence of Mainstreet's ability to create shareholder value even in times of rapid macroeconomic transformation." He added, "By adhering to our proven corporate strategy, we have insulated Mainstreet from external changes in our operating environment while continuing to generate non-dilutive growth."

These results underscore the enduring strength of Mainstreet's value-added business model and countercyclical growth strategy, where we have proven our ability to acquire and stabilize underperforming assets in order to provide real value to shareholders.

At the same time, a series of favorable macro trends have created a positive operating environment for Mainstreet. High commodity prices and a continued post-pandemic recovery continue to drive a sharp economic rebound in Western Canada. Provincial in-migration into Alberta is at its highest level in years, international immigration rates are expected to continue climbing (based on Alberta population estimates), and it is anticipated that foreign and domestic student populations will rise as in-person classes are expected to resume this fall, all of which bolster Mainstreet's position as a key provider of affordable housing. These trends, along with our ongoing efforts to stabilize underperforming acquired assets, substantially lowered vacancy rates and increased rental revenues in Q3. As of July 1, 2022, our current overall vacancy rate excluding unrentable units was 6.1%, and just 2.87% in Calgary. 

In Q3, Mainstreet generated significant profit on the sale of properties that were acquired during COVID-19 as distressed assets for the explicit purpose of resale (136 broken condo units). The profit on sale of $3.2 million in Q3 2022 ($4.1 million as of the current date) was non-recurring, but it highlights Mainstreet's ability to identify and capitalize on fast-changing opportunities in the market.

As we enter the last quarter of 2022, the high rental season of the year, we believe positive macro trends will provide ample opportunity to pursue our 100% organic, non-dilutive growth model, backed by our current liquidity position of approximately $300 million. We plan to complement that approach by continuing to improve our operational performance, including aggressively repositioning units in an effort to boost NOI. We believe this trusted strategy, coupled with the long-term durability of the broader rental market, will allow us to continue our 22-year legacy of delivering shareholder value no matter the state of our external operating environment. 

Despite a positive operating environment for Mainstreet, the war in Ukraine and lingering supply chain constraints have driven inflation rates higher and introduced wider economic uncertainty. In addition, on July 13, the Bank of Canada increased interest rates by 100 basis points, the biggest one-time increase since 1998. These higher interest rates raise the cost of Mainstreet debt, our largest expense alongside acquisitions.

Our management team has taken steps to minimize our exposure to such fluctuations, including the decision a few years ago to pay higher up-front borrowing costs on CMHC-insured mortgages in order to extend our debt obligations over longer periods (10 years instead of the typical five). Those efforts have allowed Mainstreet to lock in 99% of debt into fixed-term CMHC mortgages with an average maturity and interest rate of 7.1 years and 2.53%, respectively.

Inflationary pressures meanwhile increase the cost of everything from labour to materials, raising our operating costs. Renovation and maintenance costs have increased in line with supply shortages for materials. To cushion against such increases, Mainstreet has long established direct contracts with both domestic and foreign suppliers to attempt to secure stable supply links.

Labour markets remain tight, with job vacancies reaching more than 890,000 positions in Q1 2022, a near record-high. This has raised Mainstreet's labour costs and made hiring more challenging. Still, Mainstreet enjoys a well-established hiring record, while foreign worker programs remain available should we need to fill any additional worker shortages. 

Major fixed expenses like property taxes, insurance, and utilities have increased due to government policy. Carbon taxes, which place the financial burden on property owners, are scheduled to increase on an annual basis. We have addressed higher energy costs by entering various longer-term natural gas contracts, pursuant to which Mainstreet currently pays well below current spot prices. 

Regardless of our widespread efforts to counteract inflation and rising interest rates, higher costs erode our operating margins and negatively impact our bottom line. Some of the financial burden will ultimately be passed onto tenants through rental increases. However, we are confident Mainstreet will remain the leading provider of quality, affordable housing in Western Canada, given our track record of operational efficiency, value creation and sound management. 

As we look ahead, Mainstreet believes macroeconomic volatility could continue to keep inflation elevated, potentially leading to further interest rate hikes. To guard against such increases, our management team has ensured that the vast majority of Mainstreet debt is set at long-term fixed rates (see Challenges section).  

Further, 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.

As the acquisition environment enters a period of transition, we continue to see risk-adjusted opportunities for growth, supported by our sizeable liquidity position. Higher interest rates could force more distressed sellers onto the market, which would create more opportunistic acquisition opportunities and offer considerable potential for non-dilutive growth. As always, we will maintain our strategy of counter cycle growth by acquiring assets only when it prioritizes true value creation. For example, Mainstreet acquired a distressed property in Regina for a recorded low price of only $64,000 per unit in Q3 2022.

Meanwhile, we expect that Mainstreet's strong Western Canadian asset base, reaching from British Columbia to Manitoba, will continue to form the bedrock of future growth. We expect our Alberta and Saskatchewan markets to continue benefiting from high commodity prices, which remain elevated amid shortages of oil, natural gas, grains, and other essential products. Oil benchmarks have traded around US$100 per barrel since early this year and are expected to remain robust, which could cushion some of our core markets against the most severe aspects of a potential economic downturn. 

Positive migration trends should also continue to create ideal operating conditions for Mainstreet in the last quarter of 2022 and into the 2023 fiscal year. In-migration into Alberta reached 16,510 in Q1 2022, among its highest levels since commodity markets crashed in 2015. Saskatchewan's in-migration levels reached 2,397 people over the same period, up from 777 people a year earlier. 

We also anticipate that immigration level will continue to rise and more foreign and domestic students will return to in-person classes, 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 supportive of that trend. We expect that an increase in foreign and domestic students will be particularly supportive of our Edmonton market, where Mainstreet has built up a sizeable student housing cluster in the major college and university hubs. In Q4 2022, we expect vacancies in those areas to improve significantly as students register for the coming academic year. 

We expect our Vancouver/Lower Mainland market will continue to drive 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 44% of our net asset value ("NAV") based on IFRS value. With an average monthly mark-to-market gap of $530 per suite per month, 99% of our customers in the region are below the average market rent. That translates into approximately $20 million in NOI growth potential after closing the mark-to-market gap of $530 per unit per month, according to our internal estimates.

Current market conditions also create opportunities to extract more value out of existing assets. Mainstreet vacancy rates dropped in Q3 2022, but we still see ample room to continue repositioning units in coming quarters to further lower vacancies and boost operating income. In Q3 2022, 2,224 units out of a total 15,825 (14% of our portfolio) remain un-stabilized, largely due to our high rate of counter-cyclical acquisitions over the past two years.

Lastly, a chronic housing shortage, high interest rate and inflation will continue to make owning a home unaffordable for average Canadians. This reinforces Mainstreet's conviction that inner-city, workforce affordable rental housing will remain an essential and safe asset class in Canada. Mainstreet's rental rates are perfectly positioned to attract those seeking affordable and quality homes in today's market.

1. Pursuing our 100% organic, non-dilutive growth model: Using our strong potential liquidity position, estimated at $300 million for the remainder of fiscal 2022 (including $43 million cash-on-hand, and a $130-million line of credit secured by $312 million in clear title assets), we believe there is significant opportunity to continue acquiring underperforming assets at attractive valuations.
2. Boosting NOI: As of Q3 2022, 14% 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 $20 million, which mainly represents leveraging our mark-to-market gaps. Management also expects that strong immigration and economic recovery in Alberta and Saskatoon would accelerate our NOI catch up.
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.

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SOURCE Mainstreet Equity Corporation