Apartment Investment and Management Co (AIV) 2016 Q3 法說會逐字稿

Good afternoon, and welcome to the Aimco third-quarter 2016 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Lisa Cohn. Please go ahead.

Thank you and good day. During this conference call, forward-looking statements we make are based on management's judgment, including projections related to 2016 and 2017 results. These statements are subject to certain risks and uncertainties, a description of which can be found in our SEC filings. Actual results may differ materially from what may be discussed today.

We will also discuss certain non-GAAP financial measures, such as AFFO and FFO. These are defined and are reconciled to the most comparable GAAP measures in the supplemental information that is part of the full earnings release published on Aimco's website.

Prepared remarks today come from Terry Considine, our Chairman and CEO; Keith Kimmel, Executive Vice President in charge of property operations; John Bezzant, our Chief Investment Officer; and Paul Beldin, our CFO. A question-and-answer session will follow our prepared remarks. I will now turn the call to Terry Considine. Terry?

Thank you, Lisa, and good morning to all of you in this call. I appreciate your interest in Aimco. The Aimco headline is this: business remains good and on track. We expect to meet or beat our guidance for the full year, guidance which Paul has already raised twice.

Before turning to the details of the third quarter, I'd like to take a minute to discuss the bigger picture. Of course, there's always turbulence in markets, and there's certainly some today. In some sub-markets, there's so much new supply at A price points that it cannot be easily absorbed, leading property owners to discount rents to gain occupancy. This is painful for those property owners and their neighbors, if they are A-price-point competitors. It is also predictable.

Aimco portfolio strategy is designed for just such times. We emphasize price-point and geographic diversification. We allocate half of our capital to B and C price points, which are less affected by new supply. We emphasize lower turnover and higher renewal rates, reducing the need to discount rents to attract new customers. And we invest across many sub-markets, each with a somewhat different building cycle.

The best strategy is no better than its execution. As Keith will report in a few minutes, the Aimco team continues to do a good job in executing its plan. Here is one example. Paul told you at the start of this year that we were focused on the lease-up of vacant properties, some then still under construction. Paul also told you that we would be very transparent to investors as to our progress.

Here is the update. We began the year with about 1,300 units of lease-up exposure. We sit today with fewer than 500 of these units remaining, and we expect to finish the year with about 150 of such units, an almost 90% reduction, before adding about 300 units this year in additional phases at The Sterling and Park Towne Place, based on the continuing success of those redevelopments. At Indigo and One Canal, the pace of our leasing is ahead of our underwriting by six to nine months.

The successful lease-ups across the country are due to disciplined capital allocation by John and his team, as well as excellent work by Keith and his leasing teams in Boston, Cambridge, Philadelphia, and Redwood City. We're now busy with plans and budgets for next year. Paul will provide detailed guidance for 2017 and a forecast for 2018 on our fourth-quarter earnings call.

Until then, here's what I see. We plan to stick to our same strategy, emphasizing customer satisfaction in cost control and operations, lower risk in accretive redevelopments, disciplined capital allocation based on paired trades, a safe balance sheet with nonrecourse long-dated property debt and limited exposure to capital markets, plus an intentional team culture emphasizing collaboration and performance.

The 2017 forecast that Paul made earlier this year seems likely to be roughly right. Property operations will generally be similar to that forecast. Contributions from lease-ups will be greater, based on the good work done this year that I just mentioned. And interest expense savings from refinancing will also be greater, as rates are lower than was forecasted. Broadly, I expect 2017 results to be in the same range as they have been for the last four or five years.

For these good results and for the optimism and confidence that I feel about next year and beyond, I offer sincere thanks to my Aimco teammates here in Denver and across the country. It's a privilege and a pleasure to work with you. And now for a more detailed report on third-quarter operations, I would like to turn the call over to Keith Kimmel, Head of Property Operations. Keith?

Thanks, Terry. I'm pleased to report that we had a solid quarter in operations. Revenues were up 5% year over year. Expenses were up 2.4%, with net operating income up 6.3% for the quarter. The rate of growth in both revenue and net operating income accelerated versus the third quarter of 2015.

As a result of our team's hard work across the country, we achieved blended lease rate increases of 4.1% in the third quarter. Our residents gave us our 12th consecutive quarter of better than a four-star rating in customer satisfaction. This contributed to renewal rent increases of 5.3%, our sixth consecutive quarter of 5% renewal growth or better.

There were no significant differences in renewal rents between our A and B communities in similar markets. We saw particular strength in Seattle, Boston, Atlanta, and Denver. Renewal rents in these markets increased between 7% and better than 8% compared to the expiring leases.

Our same-store portfolio saw new lease rates increase by 3%, led by our B communities, with rate increases north of 4%, outperforming our As by 270 basis points. We saw particular new lease strength in Seattle, Boston, San Diego, and Denver, with increases between 6% and 16%.

Shifting to resident turnover and quality. Turnover for the quarter was 47.2%, in line with our third quarter of 2015. Of the customers who decided to move out, 27% were for career moves, 18% did not renew due to price, and 14% moved out to purchase homes. There are no significant changes in these move-out reasons versus recent quarters or our long-term averages.

Our resident quality continues to improve. The average incomes of those new customers who moved in during the third quarter was $156,000, with a median income of $100,000. Year over year, the median income of our new residents was up 5% compared to the third quarter of 2015.

Turning to revenue growth. Our 12 target markets were up 5.3% for the quarter versus 5% for the entire portfolio. Our top performers had revenue increases from about 8% to better than 15%. This was led by Seattle, followed by Boston, San Diego, and Denver. Our strong performers, which had revenue growth from almost 5% to 7% were the Bay Area, Los Angeles, and Atlanta.

Our steady markets with more than 3% to 4% revenue growth were Chicago; Washington, DC; and Philadelphia. Of note, our Washington, DC portfolio neared 4% in revenue growth for the quarter, signaling its recovery from a lengthy period of operating in an over-supplied market. Finally, finishing up by more than 2%, we had New York City and Miami.

As we enter our off-peak leasing season, we've made a strategic decision to build occupancy heading into 2017. This decision resulted increasing October's average daily occupancy by 50 basis points to 95.9%. While not yet complete, preliminary October lease rates have blended lease rates up about 2%, renewals up 5%, and new leases roughly flat. In November and December, renewal offers went out with 4% to 7% increases.

With great thanks to our teams in the field and here in Denver for your commitment to Aimco's success, I'll turn the call over to John Bezzant, our Chief Investment Officer.

Thank you, Keith. During the third quarter, our investment activities were focused on continued upgrades to our portfolio through redevelopment. We also closed on the previously announced acquisition of Indigo in Redwood City, California. And I'm pleased to report that we made significant progress on our lease-ups at both Indigo and One Canal in Boston.

We invested $44 million in our redevelopment activities, $16 million in the continuation of projects we were executing in phases, $10 million in new starts, and the balance in several smaller projects in planning within our redevelopment pipeline. Our phased redevelopment projects include Park Towne Place and The Sterling, both located in Center City, Philadelphia, and the Palazzo in Los Angeles.

At Park Towne Place, we are working our way through the four residential towers, with construction completed in the South Tower and nearly complete in the East Tower. Earlier this month, we began construction on the North Tower.

As of September 30, we completed approximately 60% of the total apartment homes approved for redevelopment, and of those completed homes, 76% were leased. Rental rate achievement across the redeveloped buildings is in line with underwriting.

We also continued the final phase of our redevelopment of The Sterling where 91% of the completed apartment homes are leased and rents with consistent with underwriting. During the quarter, we started new projects at Saybrook Pointe in San Jose, California; and Yorktown in suburban Chicago. Detail on these projects is included in Schedule 10.

As I mentioned earlier, during the third quarter, we closed the acquisition of Indigo. Our lease-up of this community began earlier this year while it was still under construction, with the first occupancies on July 1. At acquisition in August, the community was 27% leased. As of today, Indigo is over 63% leased. The lease pace is well ahead of our underwriting and rents are in line with underwriting.

At One Canal, where we received our final certificate of occupancy this month, we have seen an outstanding lease-up as well. Currently, over 81% of the apartment homes are leased at rents above underwriting.

I'd like to take a moment to thank our teams at both One Canal and Indigo for their stellar efforts and success during the third quarter. As a result of their good work, we find ourselves well ahead of plan and well positioned for the fourth quarter and a successful 2017 at both properties.

As to sales, we sold one affordable community during the third quarter and anticipate the closing of over $200 million of additional sales in the fourth quarter to complete the year on plan. With that, I'd now like to turn the call over to Paul Beldin, our Chief Financial Officer. Paul?

Thank you, John. Beginning with third-quarter 2016 results, at $0.45 per share, AFFO was at the midpoint of our guidance range, and pro forma FFO of $0.55 per share was $0.01 above the midpoint of our range. The drivers of pro forma FFO outperformance were better-than-expected property operations and lower interest expense, as we take advantage of the low interest rate environment.

Now, turning to the balance sheet. As previously announced, in July, we redeemed all of the outstanding shares of our 7% Class Z preferred stock at a redemption value of approximately $35 million. In doing so, we incurred $1.9 million of redemption-related charges. These charges were excluded from the calculation of pro forma FFO.

We also prepaid at par $168 million of property debt with a weighted average interest rate of 5.67%. And in September, we closed on $145 million, 10-year fixed-rate nonrecourse loan at a 3.34% interest rate, which represented a spread of 152 basis points above the 10-year Treasury rates.

At the end of the third quarter, we had outstanding borrowings on our credit facility of $295 million. We expect to repay the line borrowings with proceeds from fourth-quarter property sales and a new 10-year fixed-rate nonrecourse loan of approximately $150 million. The spread on this loan has been locked at 140 basis points above the 10-year Treasury.

At year end, we expect no significant line borrowings, and that our trailing 12-month leverage to EBITDA ratio will be 6.7 times, consistent with our beginning-of-year guidance. We expect a further decline in leverage in 2017. On a run rate basis, we are forecasting fourth-quarter 2017 leverage to EBITDA of approximately 6.0 times, driven by the completion of the Indigo and One Canal lease-ups, as well as earnings from our redevelopment activities.

Looking forward to the remainder of the year, we are increasing the midpoint of our full-year 2016 pro-forma FFO guidance by $0.01 to reflect the third-quarter out-performance, and are maintaining the midpoint of our AFFO guidance to reflect additional capital spending to maintain our properties. In yesterday's release, we also established fourth-quarter pro forma FFO guidance of $0.58 to $0.62 per share and AFFO guidance of $0.50 to $0.54 per share.

In same-store operations, with overall third-quarter results in line with our expectations, we narrowed our full-year guidance for same-store revenue, expense, and NOI growth. The midpoints of each range remain unchanged.

For the year, we expect revenue growth of 4.7% to 4.8%, expense growth of 1.8% to 2.2%, resulting in an NOI growth of 5.75% to 6.25%. For the fourth quarter, we project same store NOI growth of 5.75% to 6.75% when compared to the fourth quarter of 2015.

We will provide full 2017 guidance as part of our fourth-quarter earnings call, once we've completed our budget process. However, as a preview, we expect 2017 property operations to look a lot like the forecast that we published at the beginning of this year.

While some markets have softened, potentially reducing rent growth, we see opportunities to outperform by improving occupancy and controlling costs. And we currently expect that our 2017 NOI growth will fall within the forecast range of 4% to 5.5%. I look forward to sharing the details of the guidance with you in February.

Before we take questions, I'd like to point out a change that we made to our supplemental schedules. As many of you know, the Securities and Exchange Commission recently publicly clarified their position regarding the presentation of proportionate financial information. In response, we revised the presentation of supplemental Schedules 2, 3 and 4, and we provided a detailed explanation of the revisions on page 10 of the earnings release package.

With that, we will now open up the call for questions. Please limit your questions to two per time in the queue. Laura, I'll turn it over to you for the first question.

Thank you.

(Operator Instructions)

Our first question will come from Jordan Sadler of KeyBanc.

Hi, good morning. It's Austin Wurschmidt here with Jordan. Terry, you mentioned that the property operations were trending pretty much in line with your 2017 forecast. So just curious on the nonrecurring items, where you are in terms of the wind down from the affordable and asset management business.

Austin, that's a good question, but I'm going to turn that to Paul because he is the master of those details.

Austin, thank you for the question. On the wind down of the affordable asset management business, there's really two components to that. The first relates to the amortization of our deferred tax-credit income. And then in our outlook that we prepared for 2017, you will have noted that that drops from 2015 to 2016, and then 2016 to 2017 by roughly a $5 million or $6 million each year. We continue to expect that decline as well.

The other component of the wind down relates to the operations of the properties themselves. And so over the course of the next few years, John and the team will work hard to sell those properties as they end their compliance periods and enter the remaining five-year period, under which we have to maintain compliance with the programs but do have the ability to sell. John, would you add anything to that?

So does --

Austin, is that responsive to your question?

Initially I think you guys said at the beginning of the year $0.09 to $0.10 of dilution next year from the wind down. I'm just curious if that's still intact or if that's accelerated at any point.

It's still intact, Austin. I think for the total non-core earnings bucket, which is comprised of the deferred tax credit income, nonrecurring management revenues, historic tax credits, and then just our other tax benefits or expense, that $0.09 to $0.10 range is still intact.

Thank you. Switching over just on the investment side, with Indigo and One Canal, you've talked about those leasing up well ahead of your expectations. I was just curious if you're evaluating any other development or lease-up-type investment opportunities as you look across the portfolio and look to meet any other portfolio management objectives.

Austin, this is John. We look at opportunities regularly, and always have our toe in the market, within our target markets to see what's out there. But right now we don't have anything on the immediate horizon.

Thank you.

The next question will come from Nick Joseph of Citigroup.

Thanks. It's been a year since you announced the Indigo acquisition. I appreciate the update on the occupancy, the leasing, and the rents. What are your current expectations for the stabilized yield and how has that changed since initial underwriting?

Nick, it's right on track with the initial underwriting. We would look at a yield there that would be high 5s when we get fully -- excuse me, high 9s, low 5s, (inaudible) there for a second, [high 9s], high 4s, low 5s, as we stabilize out in the next couple of years.

To clarify, yes, when we announced the acquisition last year in the third quarter, we had discussed a stabilized NOI yield of 4.9%, and we're on track to hit that number.

Okay. What year is that stabilization?

It's upon NOI stabilization. So it's once you complete the lease-up, and you have a full year of lease turns, so we're about, say, 18 months or so out from that now.

Okay. Thanks. And then, Terry, you've talked about and talked about at the beginning of this call how different markets and sub-markets will be over built at different points in the cycle. We've obviously been focused on Northern California, New York, Houston. But looking ahead over the next 12 to 24 months, which of your markets are you watching or would most concern you that maybe we aren't focused on today?

Well, Nick, that's a good question. And what I would say at the beginning is that you really have to think about it at a very specific market level. So it's not just the Bay Area, but [Marin County] will behave very differently from Peninsula, from San Jose and from Fremont. But for the specific markets, I'm going to ask Paul to speak.

Nick, we put together an analysis in the third quarter that looked at the expected number of deliveries between the third quarter of 2016 through the second quarter of 2017. And we looked at it at the sub-market level, and because it's important to note that sometimes supply in a couple sub-markets down the road will have little to no impact on a community where there's no direct competition.

It's also important to remember the impact of the price points. And so as we looked at this, the potential impact of supply, we bifurcated it in a number of ways. We looked at our GAV that was not exposed to any new supply, that's about 13%. Then we -- the next cutoff was a 1% of new supply, there about another 19% of our GAV that falls into that bucket.

We have about 23% of our GAV that has new supply of more than 1% but less than 2%, and the reason that 2% threshold is important is because we typically see markets operating fairly efficiently at sub-2% supply levels. And that would then leave about 38% of our GAV, where you have supply greater than 2%.

And to bifurcate that down then to the price-point diversification point, we have about 16% of our total GAV is at the B or C plus price points, so a lesser effect of on the comp -- on the new supply there. And that leaves about 22% of A price point communities that will incur new supply greater than 2%.

I would note that of that 22%, roughly 1% of that is expected to be sold in the fourth quarter. So the inverse of that math is that we have about 79% of our GAV that we don't expect to be meaningfully impacted by the new supply.

Now then to actually answer the question you asked, I would say that for Aimco's portfolio where we see exposure at that A price point, we see it most notably in the downtown South Beach area of Miami at our Flamingo, Baypark and Yacht Club communities, and then also at in Center City, Philadelphia. Although, I would note that a portion on that new supply is supply that we will be delivering over the course of the next nine months or so.

Thanks. That was great color.

Next we have a question from Nick Yulico of UBS.

Thanks. Paul, just going back to your comment about the 2017 forecast for same-store NOI being, I think you said the same as the original outlook given earlier this year. Is your confidence in that driven by the fact that you guys got lower expense growth this year? Earlier this year, you reduced your expense growth forecast. Is that what's driving more of the comfort level versus revenue, maybe the revenue growth expectation?

Yes, Nick, our comfort level in our NOI range that we provided for 2017 of between 4% and 5.5% is driven as much as anything as opportunities that we see within our own portfolio. We continually focus on ways to be more effective on-site, to spend more efficiently, and we have a couple of ideas that are teed up that we're discussing as we go through the budget process.

We also think revenue growth for 2016 has performed largely in line with our expectations. So we think that our jump-off point for next year will be fairly similar to what we expected at the beginning of the year. And we also think that new -- excuse me, that renewal lease rates will be largely consistent with our model that we modeled at 4.5%, which leaves the variable on new lease rates.

And as we look at the third-party projections for new lease rates for next year at the sub-market level, we've seen a decline, but it's been a very slight decline. And so, based upon all the data we have now and what we think the range that we provided is so likely to be achieved.

Okay. That's helpful. Terry, can you talk a little bit about your appetite to do acquisitions? Do you feel you need to still upgrade the quality of the portfolio in terms of newer -- adding more newer buildings? Or do you like having the heavier Class B mix as we are getting a little bit later in the apartment cycle?

Nick, we are quite pleased with our current portfolio allocation, but not at all satisfied. We're always interested in trying to make it better. And in looking at our portfolio, the first thing that we think about probably would not be price points, but would be the quality of locations. And so the opportunity to buy, particularly in locations, for example, such as La Jolla and Marin County, would always be of interest to us.

In terms of price point, we like the mix between A and B, and our interest in an acquisition would most likely be at a B price point. But again, opportunities emerge unexpectedly, and Indigo is an example of that, where we bought an A asset on an opportunistic basis that I think will be highly accretive. So we have that philosophy as we look at the market. We're not deal junkies; we haven't made a new commitment to acquire a property in 18 months. We've typically averaged three or four a year over the last five or so years. So it's something that we look at quite actively, but I don't expect to see tons of activity.

Okay. Appreciate it.

And our next question will come from Rob Stevenson of Janney.

Good afternoon, guys. Paul, just an ancillary question based off of, it looks like that this is the first quarter that you guys have ever had a preponderance of Class A units in the portfolio. I think it's now up to 51% on one of your schedules. What does that do to you guys in terms of the replacement, capital replacements or the AFFO non-revenue maintenance adjustment going forward?

Are you looking at 2017 and beyond with a newer portfolio than you've had in the past at a significantly lower annual per-unit cost on that? How should we be thinking about that?

Rob, this is Terry. I would like to take an answer at that an then ask Paul to comment. Broadly, owning newer assets does not reduce the rate of depreciation. It may reduce the rate of cash costs, but one of the deficiencies of the FFO measure is it doesn't acknowledge the continuing depreciation, which is quite similar between A and B. And so, the more likely outcome is that over time, we will increase the $1,200, reflecting monetary inflation.

Okay. And then back to the expense question, Paul, you guys have been trending at a 2% same-store expense growth. You guys have been really handling taxes I think better than most of the peers at only up 3.5% year to date, and even on your on-site payroll where a lot of your peers are bemoaning the fact that it's spiraling upward, for you guys it's only been up a little less than 4% year to date. How confident are you at being able to keep expenses down in the 2%, maybe in the 2.5% range going forward? Is there any give-back where you have difficult year-over-year comps and we're likely to see expense growth jump into the 3%s or higher?

As we look at expense growth for 2017, Keith and I actually had the opportunity to review the first cut of the budget about a week ago. And what struck me as we went through the discussion on the number of innovative ideas where we think we have the opportunity to be more efficient with our labor, more efficient with our spending, with contract maintenance, and with -- in turns. And because of that level of detail that we undertake as part of the budget and planning process, I have a great deal of confidence for next year that our same-store expenses, while they may not be the 2% that we've guided to this year, they will likely be below the 3%, which was the high end of our range that we provided for 2017.

Okay. Perfect, guys. Appreciate it.

And the next question comes from John Kim of BMO Capital Markets.

Thank you. At Indigo, by recollection, you have a high percentage of Facebook employees there. Can you just provide an update on that? And also, many of those employees are subsidized by the Company to be near campus. Is it your understanding that that's an annual incentive or more of a one-time incentive?

John, John here. I'll take first crack at it. In terms of number in the building, it's about 15% today. And as to the incentive, we have on the operating side, incentive package for them as a preferred provider that I'll let Keith speak to.

John, I just want to clarify your question. I think you were asking does Facebook have an incentive to fund their team members to live in our building? Was that the question?

Yes, either at your building or close to headquarters.

And what we are have done is the numbers that John is talking to are these are individual leases with individual team members that work at Facebook, and so this has not been a Facebook-funded population of residents that live at our community. These are actually individual Facebook team members who said because of proximity the campus and only being nine miles away and close proximity to the train, and our particular location, they have chosen us over many of the other places in which they've had some of those contract deals.

Okay. And then Paul, I think in your preview for 2017, you mentioned that there are potentially markets where you can gain occupancy. Can you just elaborate on that statement?

Actually, I'll let Keith talk about maybe some broad, general market expectations for 2017, particularly related to occupancy growth.

John, can you just clarify the question for me real quick. You're asking what markets we think occupancy will change year over year, or what was it specifically?

I think there was a commentary on 2017, even though the conditions have gotten tougher in some markets that you would be able to make up for that in expense reduction and occupancy gains. I'm not sure (inaudible).

Got it. Let me -- I'll walk you through that, John. Really where we see the opportunity is when we think about the time from when a resident moves out to a time that a resident -- a new resident will move back in, it's really bifurcated into two pieces. One being the first one, which is turn time, how long it takes to turn the apartment.

The second piece is, we describe it as vacancy after turn, or short-term of that. And what we do is, is we believe there's an opportunity to improve that position over the next year because of our focus on efficiencies and a variety of other models that we think that we can pick up a day or two or maybe even more than that in condensing that time period.

Thank you.

(Operator Instructions).

And our next question will come from Michael Kodesch of Canaccord.

Hey, guys. Thanks for taking my question. Most of my questions have been answered, but just two more from me. The first one is as it relates to 4Q guidance, just looking at some of your lease trends from July through September and even October, we're starting to see a deceleration. You guys did 6.3% NOI growth in 3Q, and your midpoint for 4Q is close to that. Can you just help us get more comfortable with how you see trends continuing through 2016 to hit that NOI guidance number and where you expect to see improvement? Thanks.

You bet, Michael. Really the secret at this point in the year to achieving revenue growth guidance for us or just revenue growth period comes down to occupancy levels. And so at this point, on a real rough, rough math if we enter into a lease that's up or down by 100 basis points, the impact on the remainder of the year is maybe $100,000 or so.

Where we see the real benefit is growing occupancy. And where we are planning currently, we see the opportunity to grow occupancy by, say, 30 to 40 basis points. Keith noted in his remarks that we're up 50 basis points in October, and we actually have fewer lease expirations year over year in November and December than what we had year over year in October. So we feel like we're well set up to achieve that occupancy gain.

Okay. Great. That's really helpful. And then just as it relates to 2017 dispositions, I believe your initial outlook called for about $200 million dispositions at the midpoint. Do you guys still expect to achieve that in 2017 or just with some of the affordable portfolio winding down or is that still the expectation?

Michael, we actually expect for our dispositions likely to come down from that $175 million to $225 million range that we provided. And part of that is due to the fact that we have accelerated some of those planned sales in 2017 into 2016. And so our sales in the fourth quarter here will prefund, say, roughly $50 million of our cash needs for 2017.

Great. Thanks. That's all from me.

This concludes our question-and-answer session. I would like to turn the conference back over to Terry Considine for any closing remarks.

Thank you all very much for your interest in Aimco. Please call Paul or Lynn Stanfield or myself with any questions you might have, and for those of you who are attending NAREIT, we look forward to seeing you in Phoenix. Have a good day.

The conference is now concluded. Thank for attending today's presentation. You may now disconnect.