Description

Company Overview

Interrent REIT (TSX: IIP-U) is an owner and manager of apartment properties in Canada, primarily in the Greater Toronto Area ("GTA"). 70% of the ~13K owned suites are located in Ontario in which 3.6K of those suites are slated for value-add activities

Investment Thesis / Catalysts (TP 30-40%)

• Misinterpretation of NAV Erosion Impact and Generational Discount to NAV

o Implied cap is ~5% vs. a portfolio that likely is valued at a 4% cap rate after factoring in 25bps of cap rate expansion. Private market transactions still validate a mid to high 3% cap rate on the IIP portfolio. Fears of rapid cap rate expansion does not account for the income growth in an inflationary environment. With mark to market rents of ~27%, the fully baked implied cap rate is actually within the low 6% cap range for longer term investors, creating an adequate spread vs. the Canadian 5 year in the low 3% range

o Currently there is a belief that a recession is imminent. Historically, apartments are the most resistant to rent drawdowns relative to other real estate subsectors. During the GFC, the multifamily subsector saw rents decline for 5 quarters vs. industrial, office, and retail rents which declined 13, 9, and 21 quarters respectively. Recovery is also faster, achieving pre-recession rents after 12 quarters vs. other subsectors taking 30+ quarters to recover

• Fall Reopening Surge (Immigration and International Students)

o The back half of 2022 poses as a catalyst for income growth in the GTA focused apartment names. This is the first COVID-free fall wherein immigration and international students finally return in full force. Combined with a market with minimal new supply dampened by COVID related construction delays, we are entering a multi-year period of extremely high demand and low supply

▪ The Federal government is attempting to bring approximately 1.33mm immigrants to Canada over the course of three years. In which, precedent data suggests 35% of these immigrants would settle in the Toronto metropolitan area from 2022-2024 (a >7% increase vs. today’s current population) (Source: Government of Canada)

▪ Over the course of 2010-2020, there was a 135% increase in international students in Canada. Despite the impact of COVID 19 restrictions, Canada saw the return of international students per year, back to pre pandemic numbers in late 2021. 47% of international students coming to Canada come to study in Ontario, representing over 292k people in 2021. (Source: Canadian Bureau for International Education)

• Push for Affordability Drives Apartment Rents

o Though interest rates have risen, home prices are still elevated with mortgage payments rising. Therefore, the current cost to own vs. rent spread is elevated. This has resulted in minimal vacancy in the apartment space and market rents to accelerate

• Regulatory Fears Unreasonable

o GTA apartment names have been double tapped with overhangs this year due to interest rate fears and regulation risk. The Federal Liberal government plans on addressing the “financialization of residential real estate” by the end of 2023 and

performing a “review of the tax treatment of large corporate owners of residential properties such as REITs”. Many investors are now on the sidelines as they await the policy announcement which likely comes in the Fall Economic Statement, often issued in November. Apartment REIT CEOs have been educating key officials behind the scenes on how Apartment REITs contribute to affordability and are pushing back on the notion of REITs “amassing large portfolios of Canadian rental housing” as REITs only make up ~4% of national rental inventory. These conversations have proven to be incrementally positive. There is an increasing confidence that the potential loss of REIT status is unlikely, and draconian measures to suppress income growth at these REITs just increases the problem.

• M&A Catalyst Backstop

o Greater entrance into the market by Blackstone: In the month of May this year, Blackstone announced they will be expanding in Toronto. Most of their portfolio is composed of industrial and apartments, and with billions of capital to deploy, it is reasonable to assume they would consider taking a look at IIP.

o Consistent Demand for Assets by Large PE: There has been consistent interest from large private equity players on GTA apartments with buyers such as Starlight, Quadreal, Q Residential, and Homestead over the last few years

o Willingness to Sell Increases: Mike McGahan, has recently shifted from being the CEO to now being the Chairman. His more hands-off approach to the REIT and greater focus on his private entity, CLV, increases the willingness from management to let go of the company.

o Smaller size and higher MTM rents relative to peers makes IIP a solid bite size for larger buyers

Valuation

• Relative to management's current IFRS NAV, the stock trades at a 30% discount to NAV. This surpasses the discount during COVID and is only matched by the valuation during the GFC. This is compared to the pre-covid long-term average of a 5% premium.

• As mentioned above the current implied cap rate using forward NOI estimates results in a 5% cap rate implying 130bps of cap rate expansion according to the public market. The private market has still been transacting in the 3 handle range as there is a lag. But, the cap rate expansion is unlikely to be as dramatic as the public market is suggesting, given the consistent bid by private players, and less sensitivity to cap rate expansion during recessionary environments. It is not an unreasonable to believe bond yields should lower, as they suggest a more doveish Fed before the private market lag adjusts cap rates to where the public market states it to be.

Risks

• Regulatory changes get delayed or are harsher than expected

• Rising construction costs and supply chain issues hinder the value-add model on repositioned suites

• Increasing utility costs lower margins

• Macroeconomic uncertainty weighs on cap rates

• Association with the detatched housing market. Apartments are affordability options relative to detached homes. The impact of rising rates is more muted

Catalyst

•  Fall Reopening Surge (Immigration and International Students)
•  M&A Catalyst Backstop