market conditions in Western Canada

Mainstreet Q1 results hint at Alberta market recovery

Wednesday, February 15, 2017

Calgary-based Mainstreet Equity Corp. released favourable Q1 results yesterday, indicating a market recovery in Western Canada may be on the horizon.

The corporation, which specializes in add-value, mid-market apartment properties, attributes its Q1 financial success to improved conditions in B.C. and the implementation of the strategic plan it created more than a year ago to deal with economic challenges in Alberta and Saskatchewan.

Early 2017 macroeconomic statistics also point to healthier market conditions in Western Canada. Increased housing sales in Alberta, the approval of three pipelines for Canada’s oil and gas industry, and climbing oil prices in January are all indications of a favourable turn.

“We have certainly faced financial challenges over the past 18 months due to ongoing economic uncertainty,” says Bob Dhillon, Founder and Chief Executive Officer of Mainstreet. “However, as we enter into 2017, Mainstreet management is cautiously optimistic that we could be seeing early indications of gradual market recovery.”

With 3,725 units in Edmonton, Mainstreet Equity is the largest landholder in the burgeoning Edmonton Arena District, in which $6.5 billion in revitalization development projects are currently underway.

But despite these encouraging market recovery signs, Mainstreet continued to face challenges in Q1 2017 due to broader economic forces. Net operating income (“NOI”) from operations was down six per cent year-to-date, while funds from operations was down 20 per cent (excluding one-time pay-out penalties of $1.9 million). This was due to slower economic activity in the Alberta and Saskatchewan markets, resulting in increased vacancies, lower rental rates and increased concessions to tenants.

Moving into 2017, Mainstreet will continue to pursue the strategic plans it created over 12 months ago in response to macroeconomic challenges. These include: acquiring assets at low cost; refinancing significant portions of its pre-maturity debts at low interest rates; and continuing to buy back its own shares under normal course issuer bid.

Mainstreet financial highlights for Q1 2017:

• For the first time since Q2 2015, Mainstreet saw an uptick in same-asset revenues in Q1 2017, rising to $23.2 million from $22.8 million in Q4 2016. This occurred despite Q1 typically being a season of low activity in the rental market.

• Mainstreet continued to demonstrate the effectiveness its non-dilutive growth model by growing its portfolio without increasing share capital. Since its inception, Mainstreet’s portfolio has surpassed 10,000 units (it now has a total 10,181 units) while its total number of shares has remained at 8.8 million – the same as when Mainstreet began trading on the TSX in 2000.

• Refinanced $50.1 million in pre-maturity debt with an average interest rate of 5.24 per cent into mostly 10-year long-term CMHC-insured mortgage loans for $101.5 million at an average interest rate of 2.44 per cent and financed four clear title assets with a 10-year long-term CMHC-insured mortgage loans for $39.8 million at an interest rate of 2.34 per cent. These financings resulted in an annualized interest savings of $1.5 million, totalling $15 million for 10 years and raised $89 million in additional funds after payout penalties.

• Mainstreet continues to grow through strategic and opportunistic acquisitions in its core markets. Year-to-day, it acquired 303 residential units for a total consideration of $28.3 million, an average cost of $93,000 per unit.

• Mainstreet maintained a sizeable year-to-date estimated liquidity position of $151 million, including a cash balance of $45 million, to pursue further potential growth opportunities.

Continued challenges affecting market recovery in Western Canada

Ongoing volatility of petroleum, natural gas and other commodity prices continues to create economic uncertainty in some of Mainstreet’s core markets. This uncertainty is compounded by the introduction of the Alberta carbon tax, which was rolled out in January 2017. The economy-wide tax is structured in a way that charges the owners of buildings while offering rebates to tenants, which in turn raises heating and electrical costs. Mainstreet currently has its electricity costs in Alberta contractually locked in at a fixed rate until April 2018. However, internal research suggests that the provincial carbon tax will add additional costs in fiscal 2018 of roughly $8.8 per unit. Additionally, increase in rent concessions, tenant turnover and bad debts also created additional cost pressures in Q1 2017.

Mainstreet’s vacancy rate was above average over the quarter. This was largely a result of a high level of vacancy across the Prairie Provinces, coupled with the $78 million in acquisitions the corporation has completed over the past 15 months. While this vacancy rate is viewed as high (9.7 per cent), Mainstreet sees it as a short-term trend as it continues to undergo its stabilization process.

Negative macroeconomic forces have likewise caused significant short positions on Mainstreet stock. The corporation believes this is partly responsible for its share price trading well below NAV. As of December 31, 2016, the short position on Mainstreet totaled 752,600 shares.

Population growth: a positive indicator

According to recent Canadian census data, Alberta’s population grew 11.6 per cent between 2011 and 2016—the highest rate in the country and more than twice the national average. The population growth over the period was even higher than it was from 2006 to 2011, when Alberta’s economic situation was, on balance, healthier.

Saskatchewan’s population growth was the second highest in the country at 6.3 per cent. Overall, the 2016 census marked the first time in Canadian history that the three Prairie provinces (Alberta, Saskatchewan and Manitoba) had the highest population growth in the country.

Mainstreet views this demographic shift as a highly positive indicator for the Alberta and Saskatchewan markets in the long term. Alberta’s population is expected to grow by 1.6 per cent in 2017 and by 1.7 per cent in 2018, according to CMHC data. Saskatchewan’s population also continues to grow, and is expected to rise by 1.3 per cent in 2017 and 2018.

Steady in-migration levels come as the rental market begins to show signs of absorption. During recent years of high economic growth, there was a rapid build out of condominiums, particularly in Alberta, which began entering the market in mid-2015. We believe this led to a lot of condominium units being owned by investors with the intention for the higher-end rental market. The economic recession and the lower in-migration level, which resulted in an oversupply of condominium rental units, created a spillover effect and caused an increase in vacancy rate in the apartment rental market. However, Mainstreet believes this oversupply will continue to absorb through fiscal 2017 and 2018.

Additionally, the corporation expects the recent relaxation of Canadian immigration policies to attract a number of foreign workers, foreign students, immigrants and refugees to some of its core regions—most of whom are likely to enter the rental market. In times of economic uncertainty, renters tend to favour middle market prices, they kind offered by Mainstreet, as they delay major investments like new homes.

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