Minto Apartment REIT Hasn't Been This Cheap... Ever

A 39% discount to NAV? Now we're talking!

After last week’s post on how to value REITs like an owner (which I think is one of the more important and timeless pieces I’ve written thus far and I’d bookmark it twice just in case), I vowed to take a closer look at Minto Apartment REIT (TSX:MI.un). Look for an upcoming post on the other cheap REIT identified in that post, Morguard North American Residential (TSX:MRG.un), too.

But first, Minto.

Minto’s property on Front Street, Toronto

Your author hasn’t spent a lot of time on residential REITs, choosing instead to focus on the more commercial side. The main reason for this was because there were always one or two super cheap commercial REITs. The market would fall out of love with a certain portfolio or a management team and send shares reeling. I’d show up right as the plan to right the ship was unveiled, usually with pretty good results. And if I didn’t get the capital gains, I’d at least collect a nice distribution.

Like my thesis for Artis REIT, which I still think is a great buy.

Artis REIT: My Top Real Estate Play for 2023

I’m much more willing to pay a decent price for a what I view as a premium business compared to a handful of years ago. But my REIT investing hasn’t evolved. I’m still much more likely to look at dirt cheap assets.

I think Minto may be relatively close to checking off both the cheap and quality boxes. It holds a bunch of newer apartment buildings in large Canadian cities, assets I think perform pretty well over the next decade. And shares are cheap, trading at a 40% discount to NAV and close to a 52-week low.

Let’s take a closer look.

The skinny

Minto Apartment REIT bills itself as Canada’s only REIT to be 100% focused on urban markets. The portfolio today stands at 32 properties, spanning 8,291 suites. with nearly 100% of the portfolio located in Canada’s six largest metros. 21 of 32 properties are located either in Toronto or Ottawa, two markets that have enjoyed excellent rent growth of late. Occupancy is above 97% and ticking up as new developments fill up.

We’ll talk more about the convertible development loans in a bit.

The company debuted on the Toronto Stock Exchange back in 2018 as the Minto parent spun off some of its apartment assets into the REIT. The parent has been a developer active in the Ottawa region since the 1950s, eventually expanding to develop all sorts of real estate across Canada and into the United States.

Minto maintains a large ownership stake in the REIT through Class B units, which have the same economic interest as the units that trade on the exchange. The parent has a ownership stake of approximately 40% and appears content to maintain that stake even when the REIT issues units.

There’s one big advantage to this close relationship with the parent. Minto develops properties, which get partially financed by the REIT through those convertible development loans. In exchange for the loan the REIT gets the opportunity to buy the newly completed asset at a discount to appraised value. It’s a nice win-win scenario.

Let’s take a look at a real-life example, a Minto development in Ottawa called Fifth and Bank. This is a mixed-use property located in The Glebe, which is home to Landsdowne Park, where most of Ottawa’s sport facilities are located. It has 163 units mixed in with some retail space. It is 100% leased as of the end of 2022.

The REIT has an option to buy the entire development, which was recently extended to June 30th. The REIT hasn’t made a decision yet, but I’d be very surprised if it didn’t snap up the asset. After all, new buildings aren’t subject to rent control. It’s a good asset to own in an inflationary environment.

The delay seems to be due to selling off the Edmonton assets to help pay for the new location, which hasn’t happened as quickly as planned.

The REIT has similar options to buy other Minto developments, including Beechwood in Ottawa, University Heights in Victoria, and both 810 Kingsway and Lonsdale Square in the Greater Vancouver Area. It also has a direct interest in a couple properties in Toronto.

Minto also has a history of partnering with other institutional investors on these types of projects, which is also an option.

The important thing to remember from all this talk about these convertible development loans is they should translate into growth over time. The portfolio size should increase by about 20% by 2026 and even further once the Toronto properties are completed.

Here’s a snapshot of the development portfolio:

One other thing I’ll mention is Minto’s debt situation, which looks pretty okay. In a world where many REITs took on variable rate debt because they were convinced rates would stay low forever, Minto spent much of the last few years locking in low rate long-term debt. It puts them in an excellent position today. They assumed some variable rate debt when they took over some Toronto assets in 2022, but plan to convert it to fixed rate.

We should also keep in mind the REIT has a conservative balance sheet with a debt-to-assets ratio of just 40%, along with a decent amount of liquidity.

One thing the market doesn’t like about Minto Apartment REIT is the external management situation. Minto manages assets for the REIT, charging a maximum of 32 basis points of gross assets. Generally, the market doesn’t like external managers, since they’re in it to make money for themselves. But this situation is a little different, since Minto holds such a large interest in the REIT. And besides, the market didn’t seem to care about the external management back in 2019 or 2020. It’s only lately it has come up as an issue, likely to help explain the big price decline.

In other words, I think price is driving the narrative a bit here.

Why it’s a buy today

Minto is an attractive investment today because it’s essentially a play on increased Canadian immigration trading at a discounted price.

For those readers outside of Canada (and surprisingly, there are a bunch of you!), here’s what you need to know about immigration. Canada wants immigrants. We’re welcoming approximately 500,000 new Canadians each and every year, with plans for an additional 500,000 per year through the mid-2020s.

There are approximately 38 million people in Canada. A half million people per year is a pretty big deal. Despite the United States having close to 10x the number of people Canada has, they only permit around a million immigrants per year.

These immigrants tend to end up in Canada’s largest cities, with a real emphasis on Toronto, Vancouver, and Montreal. These cities offer amenities like large ethnic communities, plenty of job opportunities, and an experience a little closer to home than getting plunked into a small town in Saskatchewan. Additionally, many of these immigrants are wealthy, so high real estate or rent prices in large centers isn’t a huge deterrent. For many of these people, the point of immigrating is to get themselves and their assets out of less stable countries and into something safer. And there are few things safer than Canadian real estate.

We know these people are coming, yet we’re not building enough houses for them. Housing completions are lagging far behind immigrant growth, especially in Ontario. This will translate into both higher rents and real estate prices over time. Even if higher interest rates temporarily get in the way.

That’s a good thing for an apartment REIT with large exposure to these big centers and a developer in their corner who can bring new supply into the market.

I normally don’t have much confidence predicting macro trends, but the Canadian real estate one I feel pretty good about.

Let’s talk about Minto’s valuation next, which I think is equally compelling. After years of trading at a premium to net asset value, shares have cratered just as NAV is increasing. I’m not entirely sure why, either.

A 39% discount to NAV? Yes, please.

That’s a big move. What’s changed so drastically that shares went from a huge premium to a huge discount to NAV?

Sentiment is different, for one thing. Most residential REITs have seen their valuations plunge as investors get skeptical about the way net asset value is calculated. REITs are still using cap rates in the ~4% range as the basis of their NAV calculations, pointing out that private sales are still happening at that valuation. Many investors are convinced proper cap rates are somewhere in the 6-8% range, since mortgage debt of 5% is common. Why would anyone purchase property at a 4% cap rate when it costs them 5% to service the debt?

One possible answer is increasing rents. Residential REITs are pretty much guaranteed to increase rent at the rate of inflation over time, with certain markets looking poised to perform even better. Minto has proven it can deliver exactly that.

Short-term rent increases are even more impressive. Check this out.

The stock is also pretty cheap when we combine the equity and debt together and look at it from a return on investment perspective. Minto’s cap rate (enterprise value divided by NOI) is approximately 6% today. I think NOI goes up in 2023 because we should get a boost from new developments and rent increases on current units. This will be offset somewhat by the sale of the Edmonton assets.

I think the REIT can easily increase NOI by 5% annually through 2026, meaning we have a forward NOI yield of above 6%, increasing to more than 7% by the time 2026 rolls around. Combine that with a return to NAV — which should go up over time — and I can see the stock trading at $25 in a few years, plus the dividend. That’s not a bad total return profile.

Minto isn’t as cheap on a price-to-FFO basis, but is still a reasonable buy from that perspective. It’s on pace to earn approximately $0.85 per unit in FFO for 2023. Shares are approximately $16.50 each. That gives us a trailing price-to-FFO ratio in the19x range. $0.90 per share seems like a reasonable FFO target for 2023, putting shares at 18x forward FFO.

Note that Minto’s conservative capital structure (less than 40% debt-to-assets) is one reason the price-to-FFO ratio is higher. They have room to increase the amount of debt on the balance sheet if desired.

Finally, a few words about that dividend. Minto has increased its payout each year as a publicly traded company, although the increases aren’t anything to get super excited about. The payout started at $0.03416 each month, or $0.41 annually. They’re currently $0.49 per year, which works out to a 3% average annual raise. Combine that with the current 3% yield and it isn’t bad, but I can see some investors wanting more.

The bottom line

I spent most of my life living in a small town before finally moving to Edmonton a few years ago. Small towns have a lot of advantages, but there are few things that beat living in a city. I understand completely why new Canadians settle where they do.

Minto seems like a very reasonable way to play this trend. It should grow slowly over time, increasing its distributions at 2-3% per year. That’s not such a bad combo.

But I’m going to hold off before I buy. Next week I’ll take a closer look at Morguard Residential REIT to see if I should put my money there instead.

Disclosure: Author has no position in any stocks mentioned, but may initiate a position in Minto Apartment REIT at any time

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