Independence Realty Trust Inc (IRT) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2016 Independence Realty Trust earnings conference call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would like to introduce your host for today's conference, Andres Viroslav. Sir, you may begin.

Thank you, Glenda, and good morning to everyone. Thank you for joining us today to review Independence Realty Trust's third-quarter 2016 financial results.

On the call with me today are Scott Schaeffer, IRTC Chief Executive Officer; Jim Sebra, IRTC Chief Financial Officer; and Farrell Ender, President of Independence Realty Trust.

This morning's call is being webcast on our website at www.IRTREIT.com. There will be a replay of the call available via webcast on our website and telephonically beginning at approximately 12 PM Eastern Time today. The dial-in for the replay is 855-859-2056 with a confirmation code of 96007206.

Before I turn the call over to Scott I would like to remind everyone that there may be forward-looking statements made on this call. These forward-looking statements reflect IRT's current views with respect to future events and financial performance. Actual results could differ substantially or materially from what IRT has projected.

Such statements are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Please refer to IRT's press release, supplemental information and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations.

Participants may discuss non-GAAP financial measures in this call. A copy of IRT press release and supplemental information containing financial information, other statistical information, and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is attached to IRT's most recent current report on Form 8-K available at IRT's website, www.IRTREIT.com, under investor relations. IRT's other SEC filings are also available through this link.

IRT does not undertake to update forward-looking statements in this call or with respect to matters described herein, except as may be required by law. Now I would like to turn the call over to IRT's Chief Executive Officer, Scott Schaeffer. Scott?

Thanks, Andres, and thank you all for joining our call today. It was a busy quarter highlighted by our agreement with RAIT to terminate the external advisory contract by our significant equity offering and, most importantly, solid operating results. Let's begin with the results.

Our operating results this quarter further support our strategy of building a portfolio of apartment communities in primarily non-gateway markets, which continued to enjoy solid population and job growth while being relatively insulated from the effects of new construction. We continue to see the potential for rent increases and NOI growth within our markets.

Earnings for the third quarter were as expected at $0.21 per share of core FFO. The portfolio continued to perform well with 6% year-over-year same-store NOI growth and stable occupancy, while the Trade Street assets continued to exceed our expectations, delivering 10.6% year-over-year NOI growth. The Trade Street properties will become part of our same-store portfolio in the first quarter of 2017.

At the end of the quarter we took a big step forward in the Company's evolution by entering into an agreement to internalize IRT's management, including the property management functions. This milestone transaction, which will close before year-end, provides management continuity as the existing management team will become full-time IRT employees. Additionally, IRT will be afforded the related benefits of being an internalized, multifamily equity REIT, including cost savings and the elimination of any perceived conflicts that result from the external management structure.

In order to facilitate a smooth transition away from the external management structure, we will enter into a shared services agreement with RAIT for a six-month period after the transaction closes.

Subsequent to announcing the internalization transaction, we launched a common stock offering to further fund the transaction, to reduce debt, and to repurchase our shares held by RAIT. We have closed on the offering netting approximately $244 million in proceeds. These proceeds, plus cash on the balance sheet, were used to reduce debt by $147 million, to buyback the 7.3 million shares owned by RAIT for $62 million, and to reserve the $43 million to pay for the internalization agreement.

Taking into account the impact of the offering, debt reductions, and expected cost savings from the internalization, our debt-to-gross assets will decline from 64% to approximately 53% and net debt to EBITDA will decline from 11.6 times to approximately 9.3 times based on annualized third-quarter results. Looking forward IRT will be internally managed with approximately 400 employees and will be well-positioned for future growth within our targeted markets.

At this point I would like to turn the call over to Farrell to discuss IRT's portfolio and then Jim to go through the financial results.

Thanks, Scott. We are pleased to announce another strong quarter of results for the portfolio. Our same-store portfolio saw a revenue increase of 4.1%, expense growth of 2.1%, which generated NOI growth of 6%. Rental rates increased 3.4% from $838 last year to $867 in Q3 of 2016 and up from $856 sequentially, or 1.3%.

NOI margin for the same-store portfolio increased from 50.8% last year to 51.7% Q3 of this year and down sequentially from last quarter, as we typically experience higher turnover and payroll costs associated with the third-quarter leasing season and higher utilities over the summer months.

Occupancy dropped 20 basis points to 93.2% as compared to Q3 2015, primarily due to lower occupancy at two of our Class C communities and 20 units that were damaged and being prepared, but are currently unrentable, at one of our Atlanta communities. The Trade Street same-store saw a 4% increase in revenue, a 4.4% decrease in operating expenses attributed to lower insurance, personnel, and successful real estate tax appeals. This yielded an NOI growth of 10.6%.

The NOI of the combined portfolio grew by 8.2% year over year driven by a revenue increase of 4% and a 0.8% increase in expenses. Average daily occupancy for the quarter was 94.1%, 10 basis points higher than where we stood in Q3 of last year.

NOI margin for the entire portfolio increased 170 basis points year over year, from 53.1% to 54.8%. Our renewal rate for the third quarter was 53% and we experienced 4.3% rent growth for renewal leases, as compared to 4.7% rent growth for new leases.

Focusing on the markets where we have the most exposure, 50% of our portfolio based on NOI is contained in five markets. Louisville, representing 12% of the portfolio's NOI, experienced 4.3% revenue growth; a decline in expenses of 3.6%, primarily due to successful real estate tax appeals; and generated NOI growth year over year of 11%.

Memphis at 10.5% produced 4.6% revenue growth, expenses remained flat, and provided NOI growth of 9.1%. Atlanta, with 10.3%, had revenue growth of 5.5%, expense savings of 2.8%, generating NOI growth of 11%. Raleigh, which contributes 9.6%, had revenue growth of 5.2%, an increase in expenses of 8.3% due to a tax reassessment at one of our communities which is being appealed. This netted NOI growth of 3%.

Oklahoma City, which provides 7.2% of our portfolio's NOI, achieved 1% revenue growth and a decline in expenses of 3.8%. The expense decrease was attributable to savings across several line items and a successful real estate tax appeal compared to Q3 2015. We were able to achieve 1% revenue growth in a market that has struggled due to the impact of the energy sector.

Fortunately, this city has diversified their economy to mitigate the impact of the energy industry on the overall economy. Job growth over the last 12 months was slightly positive and the unemployment rate stands at 4.4%, as losses in the energy sector were offset by growth in other industries such as Boeing, Tinker Air Force Base, and the state and local governments.

Little Rock rebounded with year-over-year revenue of 3.5% and NOI growth of 5.1% in Q3 as additions to supply in the market have effectively stopped. Areas that we have the most difficulty increasing rents in a past quarter were Jackson, Huntsville, and Orlando where new supply is directly impacting our Millennia 700 community.

Touching briefly on asset classes, we currently classify 27% of our portfolio to be Class A communities, 63% Class B, and 10% Class C. In Q3 we saw revenue growth of 3.2% among our Class A communities year over year, 5.1% in our Class B communities, and 2.9% in our Class C communities. We are of evaluating our Class C portfolio and may cycle out of them in 2017 with proceeds used to fund acquisitions.

Looking toward the fourth quarter, for the month of October we have seen rent growth averaging 4% among new and renewal leases and are currently seeing increases of 4.9% and 3.3% for November and December, respectively. We are actively looking to expand the portfolio in markets that we have existing communities or which fit into our geographic footprint and contain multiple demand drivers with solid fundamentals.

We are currently looking at opportunities in Indianapolis, Cincinnati, and Tampa St. Pete and as of this call, the aggregate total purchase price of the pipeline is $219 million.

I will now hand the call over to Jim to discuss the financial results.

Thanks, Farrell. GAAP earnings this quarter was $0.05 per share, or $2.3 million. Quarter FFO this quarter was $0.21 per share, or $10.4 million, up 48% from $7 million in the same quarter of last year. Our acquisition of Trade Street in September of last year, the gains on the sales of properties this year, and continued NOI growth in the same-store portfolio are the primary drivers of our positive changes in GAAP earnings and core FFO.

Our same-store portfolio, as Farrell mentioned, continued to provide positive results with an overall NOI increase of 6% this quarter, as compared to prior year. This improvement was primarily driven by the 4.1% increase in same-store revenue, while keeping expenses in check at only a 2.1% increase as compared to Q3 last year.

From a balance sheet point of view, we ended the quarter with $1.3 billion of gross assets, representing 12,982 units, $29 million of cash and $888 million of debt. There were no property sales during the third quarter.

In conjunction with the previously-announced internalization transaction, IRT completed a 25 million common share offering in early October netting proceeds of $211 million. Additionally, the underwriter exercised the overallotment option on October 21. This exercise provided IRT with $32 million of additional proceeds.

The total proceeds, plus balance sheet cash, have been used to delever our balance sheet by $147 million, repurchase all of RAIT's 7.3 million shares for $62 million, while reserving $43 million to complete the internalization in December. On a pro forma basis IRT's balance sheet has improved with debt to gross assets declining from 64% historically to 53.4% and IRT's net debt to EBITDA has improved from 11.6 times historically to 9.3 times, including the anticipated $2 million to $2.5 million of cost savings post internalization.

On a pro forma basis, as of 9/30, after reflecting all of the transactions to date, IRT's debt is 100% fixed rate with a well-staggered maturity profile and an average interest rate of 3.5%. As a result of these transactions, our balance sheet cash, and availability on our line of credit, we have aggregate liquidity of $130 million that can be used for acquisitions.

Before handing the call back to Scott let's talk about our earnings guidance for the rest of 2016.

Previously, we guided that our core FFO would be between $0.84 and $0.88 per share. Because of the recent stock offering and pending internalization, we are reducing our guidance to be between $0.77 and $0.79 per share. The reduction is due to the dilution and the drag between the timing of the equity raise and the closing of the internalization in late Q4.

Additionally, as we disclosed in the press release, we are expecting to record the payment to internalize IRT as an expense. As a result, our GAAP earnings guidance has been reduced and a corresponding adjustment to our core FFO has been added to remove the effects of that one-time transaction. The earnings release contains further information on the additional assumptions inherent in that guidance.

As it relates to 2017, we plan to give full-year 2017 guidance during our 2016 year-end earnings call in the first quarter of 2017. Also, one additional point for emphasis on 2017. As we previously mentioned, we are expecting cost savings as a result of the internalization. We estimate those cost savings to be between $2 million and $2.5 million annually. Scott?

Thanks, Jim. Operator, at this time we should open the call for questions.

(Operator Instructions) Brian Hogan, William Blair.

Good morning. Can you cover the pipeline again? I thought I heard $290 million. I just wanted to make sure I heard that correctly.

$219 million, Brian.

Okay, helpful. So in the Cincinnati, Tampa Bay St. Pete, what is the timing of that? Because obviously it appears, based on my calculations, that the dividend coverage is going to be awfully tight until you get some properties on the portfolio. So just kind of curious on timing.

Looking at first quarter closings.

First quarter closings? And then -- is that all of it? Is that kind of contractual or is it at what stage is the $219 million?

No, we are at various stages. One we are negotiating a contract; the other two we are negotiating price and doing our due diligence.

But you would expect all three properties to be closed in the first quarter?

Yes.

That is nice. The property sales, the Class C portfolio; remind me how big that is for 2017 and which ones are they?

The two that we are looking at total $36 million. It is our property in Jackson, Mississippi, and property in Indianapolis.

All right. And that timing would be late 2017?

No, early 2017. (multiple speakers) If we do it, Brian; we are still evaluating. I touched on it briefly in the call.

Those are just two assets that are historically lower occupied and tend to take up a lot of our management team's time, so we feel like it would be better to -- could potentially be better to cycle out of them into the opportunities that we are seeing.

All right. Would part of that be focusing on reducing leverage? What is your leverage targets over time?

Obviously with the recent equity raise you have reduced it dramatically and you are down to about 50% or so, which is very nice. And obviously you are a growth REIT; I understand that so you're going to run higher leverage than others. But what are your thoughts on leverage over time?

We would like leverage to continue to come down, but to your point about being a growth REIT, we want to manage that process and do it efficiently. And I think that on a gross asset base that we would like to see it down into the 40%s and on an EBITDA basis in the 7s. So we are there and with the continued growth of the portfolio or the continued growth of the existing portfolio, rent growth, and NOI growth that we will be moving towards those numbers throughout 2017. And then as we make further acquisitions that should help as well.

Sure. Then last one, how long do you think you would be able to push rates or rent increases? Obviously, it is a very nice -- you have the Trade Street portfolio, being able to execute on that. Is it another couple of years you will be able to grow 3% to 5% or so? What is your timeframe?

Listen, I think it depends on -- it is hard to project that far out. I mean it is contingent on the economy continuing to just stabilize and rent and job growth continuing to stabilize. But, yes, we have seen -- we have been pretty successful.

Our portfolio in general is pushing rents 3% to 6% and we have seen it through this last pipeline of supply. 2017 will probably have a similar pipeline of supply and then it will start to ease. So I think that as long as the economy maintains where we are today, we will be able to push rents at the same level.

And you are not seeing competitive pressures?

Again, we have some exposure in the Trade Street portfolio to new supply because of what those communities are, but for the most part, we have a large portfolio of Class B assets that are really insulated to the supply issues that you are really seeing in half a dozen markets.

The markets that we are in we still see good job growth and, to Farrell's point, limited editions to supply. Now, as with some increase in wages, we expect to push rents throughout 2017 in the 4% range in the same-store portfolio.

All right, thank you.

Steve Shaw, Compass Point.

Can you talk about the dividend and potential for coverage or if that will be maintained?

Our intention is to maintain the dividend. We recognize that coverage is tight at the moment. We felt -- and this was not a decision that was taken lightly -- throughout the strategy of the internalization and the equity raise of keeping the dividend where it is.

It will be tight, but with the forward view of the portfolio and continued NOI growth that coverage will grow and we expect it to be -- over a reasonable period of time to be at a more reasoned payout ratio or level.

Okay, and then --.

Without cutting it, of course. I have to just be clear.

Then any update on compensation, management agreements, and anything else governance related?

Everything is moving forward. We are ahead of schedule on the work that needs to be done to close the internalization transaction in late December or later December. The management team has reached agreement with the compensation committee of the Board on contracts, so I think we are in a good place.

Okay. And then in terms of the fourth quarter with G&A and asset management fees, how should we be thinking about those management fees? They are still going to be showing up in the fourth quarter?

Yes, the contract obviously is in place until the internalization is completed, so it will all continue to be calculated in accordance with those contractual provisions. So obviously, other than just kind of prorating for whatever time the internalization closes, everything else should be consistent.

It is part of the reason -- and in Jim's prepared remarks he talked about the timing of the equity raise versus the closing of the transaction, there being a drag on earnings. And it is because that contract is still in place while the money sits there in the bank waiting to pay for it.

Okay, thanks.

But it is a one-time event and we are looking forward to the cost savings in 2017 once the contract is terminated.

Brian Gonick, Senvest.

Good morning, guys. Could you just go through all of the pro forma adjustments one might do to give effect to the internalization? Just so we can understand what expenses are going away, what expenses are coming on, and what the net effect of that would be.

Sure, Brian. This is Jim. IRT has been historically running at about $2 million of total G&A, plus about $8 million of total annual kind of asset management fees. The $2 million of regular G&A that will certainly continue, but the $8 million of asset management fee will get effectively replaced with anywhere between $5.5 million to call it $6 million of additional between compensation expense and just some additional G&A expenses for rent, etc.

Okay. So that is where that $2 million to $2.5 million of savings comes from?

That is right.

Okay. Then of course, obviously, the interest expense is lower by the $40 million term loan you've paid down. And you paid down $107 million of the credit facility, is that right?

That is correct.

Okay. And that credit facility, though, you would be using to purchase these assets in Q1; is that right?

Correct, that is correct. The one thing to just note on the credit facility is that with the leverage now in the low 50% range, we will see some additional savings on the spread on the credit facility, so apparently we are at 225 basis points over LIBOR. That would drop to about 185 basis points over LIBOR in the first quarter as the result of all the recent pay downs.

But if you drawdown on that facility to make the acquisition, will be spread go back up?

The spread would go back up, but not until you are over a 55% leverage ratio.

Okay. For the assets you are buying, what kind of cash flow are you picking up from those assets?

We are buying them at anywhere between a 5.85% and a 6.20% cap rate.

Okay. Okay, great. Thank you.

Craig Kucera, Wunderlich.

Good morning, guys. Appreciate the color on the G&A next year, but you mentioned that there would be a shared services agreement for the first six months. Is that going to be all that material or should we expect a little bit higher G&A in the first half of the year I guess?

Yes, what you will see is a little higher G&A in the first half of the year. Then that G&A will come down the second half of the year, but that will get halted by the increased compensation expense in the second half of the year as all the positions are filled, fully moved in.

The shared services contract, I think it is in the process of being finalized. It should be in the range of about $100,000 to $120,000 a month. That will then go away starting with the end of that shared service period.

Got it. So when you are talking about this $2 million to $2.5 million in savings that is sort of net of that shared services, correct? That is included in there?

That is all in, that is right.

In the past you have seemed pretty confident about putting up, call it, 4% rent in your same-store portfolio, but I was curious how you felt about the Trade Street assets given that they are putting up 8%-ish same-store NOI. Are you seeing any pushback on rent at those assets or we would expect a similar kind of number next year?

No, the only pushback -- like I said, there are three communities there that over the past year have experienced the dip, just again due to new supply hitting their submarket, but they have all bounced back pretty nicely. So we may see that.

We may see that, we may not, but for the most part we have been able to push through -- with the exception of those three properties in the 3% to 7% range.

Got it. All right, that is it for me. Thanks.

Larry Raiman, LDR Capital Management.

Good morning. Just a follow-up on the last question, a better understanding of the shared services, and the prior question to that, the pro forma adjustments for internalization. I understand that the Company is going to be on, a run-rate basis, saving somewhere between $2 million to $2.5 million as you said on the call. The internalization cost is $42 million.

That $2 million to $2.5 million that includes a six-month deduct for shared services. I am just trying to understand what the pro forma run rate of savings is. And then how do you relate that on a multiple being paid on the internalization transaction of $42 million?

I will take the last part of your question first, Larry. The contract that is in place has the annual fee of 1.5% of equity, in addition to a 4 times multiple, at the end of the term. Regardless of whether it is terminated or it's just not renewed by either party.

The way we looked at it was: what is the right price to exit that contract today? It was four years to run and our view was that we felt that there was opportunity to continue to grow the business, grow the portfolio that that should happen. And if we were to continue growing the portfolio, the cost of that contract -- not only on an annual basis, but then the termination fee, if you will -- was just going to get more expensive at each turn.

So that was part of the analysis. Both companies, IRT and RAIT, hired -- they both formed special committees of independent members and each committee hired its own advisor to help them on this exact negotiation. I stepped out of it because I was on both sides of the transaction as CEO of both companies and the special committee's handled it.

To me, the price seemed fair for both sides, because of the fact that if the contract were left to run, presumably it would be more expensive each year and then again at the end it would be more expensive to get out of it. So from IRT's perspective it made good sense to cut that off now and to internalize it. In addition to the fact that we are saving anywhere from $2 million to $2.5 million -- we believe we will be saving anywhere from $2 million to $2.5 million per year going forward.

Of course that savings grows if you consider that the cost of the contract was going to be increasing in the future.

So I will let Jim answer the first part of your question, but that is how the $43 million came about.

Thanks, Larry. As I mentioned, we are saving about $2 million to $2.5 million a year in total and as I mentioned the G&A will be a little bit higher in the first six months of the year. Then that will get replaced by a little higher compensation in the last six months of the year.

So in the beginning part of year we will be running at that savings of about $2 million annually a year and then by the end of year we should be in that $2.5 million of annual savings annually.

Okay, got it. Thank you.

Daniel Donlan, Ladenburg Thalmann.

This is actually [John Socha] on for Dan. Just I'm looking at your pipeline; where do you think the focus is? Is it really more in your Class B markets or are you looking to maybe expand a little bit in that Class A -- with Class A type assets focused in secondary markets?

I would say our focus is the solid become B, B+, A- 10-year-old, 10, 15-year-old products. The Trade Street situation was a good opportunity for us and it got a nice, new, Class A, highly-amenitized properties. But as we are seeing in the portfolio just in general in the marketplace the opportunity to push rents and maintain really solid occupancy is in that Class B property.

Okay, that makes sense. Then I know you guys don't really play in the same spaces as some of the more Class A-focused peers, but there has been some kind of talk about pushback on the ability to raise rents there.

Are you worried about that maybe trickling down, particularly in some of your larger markets, like Orlando and Raleigh, beyond just supply? So there maybe a little bit less demand for those types of assets?

We haven't seen it. The only time that we have experienced any type of pushback is when new supply, especially in Orlando where you had three deliveries at one time with concessions impacting the ability to push rents. But Raleigh we are seeing really strong, across our A and B portfolio, rent growth.

Then just continuing with the TS. Did you give what the Trade Street assets did in terms of expense growth?

They were 4.4% below where they were and primary drivers are insurance and R&M.

Given we are lapping the one-year anniversary here of you guys -- we've already lapped the one-year anniversary of you guys owning the assets. I mean how much longer do you think you can continue to see expense savings within the Trade Street portfolio?

It's not going to be much longer. We might have a couple of quarters, but we have been in there for a year. You can see on the entire portfolio they become much more predictable as they are in the portfolio and in our operating process for two years.

So I think we might have a couple of more quarters, but we really --. The insurance is what it is. We are going to renew it next year and it is going to be what it was last year.

Okay, that makes sense and that is it for me. Thank you very much.

Steve Shaw, Compass Point.

Getting back to those two assets that could be potentially sold, can you talk about potential disposition cap rates on those and how they might compare to some recent dispositions? It sounds like they could be weaker assets and somewhat outliers.

It is an interesting market we are, because while we may not believe it, certain people may believe that these are value-add deals. So the people we are talking to you could see some pretty competitive cap rates on these properties because people think that they can go in there and spend $10,000, $15,000 a unit and get more rent.

We don't think so, but we will see what the market does. Potentially you are looking at potentially sub 6% cap rates on Class C product in really tertiary markets.

Thanks.

Thank you. I'm showing no further questions at this time. I would like to turn the call back over to Scott Schaeffer for closing remarks.

Thanks, everyone, for joining the call today and we will speak with you after the fourth quarter. Thanks.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.