Independence Realty Trust Inc (IRT) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Independence Realty Trust's First Quarter 2018 Earnings Conference Call. (Operator Instructions) And as a reminder, this conference may be recorded. I would now like to turn the conference over to Ms. Lauren Tarola with Investor Relations. Ma'am, you may begin.

Thank you. Good morning, everyone. Thank you for joining us today to review Independence Realty Trust's first quarter 2018 financial results. On the call with me today are Scott Schaeffer, our Chief Executive Officer; Jim Sebra, IRT's Chief Financial Officer; and Farrell Ender, President of IRT. Today's call is being webcast on our website at www.irtliving.com. There will be a replay of the call available via webcast on our Investor Relations website and telephonically, beginning at approximately 12:00 p.m. Eastern Time today.

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

A copy of IRT's 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 on IRT's website. 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 it is my pleasure to turn the call over to Scott Schaeffer.

Thank you, Lauren, and thank you for joining us this morning. The first quarter of 2018 produced positive results that were in line with our expectations and guidance provided on our last earnings call. The quarter was highlighted by successfully completing the integration and on-boarding of communities acquired in late 2017 and early 2018 as well as the initiation of the first phase of our value-add program. As of quarter-end, all 5 communities identified in Phase 1 of our program have renovations now underway.

Starting with a brief overview of our financial performance and operating results, IRT reported core FFO per share of $0.18, in line with the first quarter of 2017 and adjusted EBITDA of $23 million of 18% year-over-year. Revenue growth was strong of 8% sequentially and 17% year-over-year. Same-store NOI for the quarter grew 2% year-over-year. Our same-store NOI growth was impacted by severe weather-related incidents across a number of our core markets that led to heightened operating costs and softened leasing traffic. With the seasonal first quarter weather trends now behind us, we have already started to see a notable uptick in leasing spreads and are on track to achieve our full year 2018 guidance.

One of the critical components of our growth strategy is our value-add initiative. We have emphasized over the past few quarters that we are actively focused on identifying opportunities to make improvements that will increase rental rates and reduce operating costs, which together will generate strong returns on investment and increase value for our shareholders. Based on our belief that there are future opportunities within our portfolio, we have developed in-house capabilities that can oversee and execute on the value-add projects, providing a greater level of control and efficiency by eliminating the cost of third-party construction managers. We are happy to report that we have 5 communities underway and are on track to deliver units throughout 2018. So far, we are experiencing sizable rental growth in these 5 communities. But keep in mind, we've just started the value-add initiatives. While we expect this initiative to be beneficial later in the year as more renovated units are completed and leased at a premium, there may be some near-term volatility and occupancy at these properties. Additionally, remember that we will begin value-add projects at an additional 9 communities we identified as Phase 2 of our value-add initiative later this year. All in, over the next 1.5 years, these value-add projects are expected to generate approximately $9 million in incremental NOI annually and deliver material earnings accretion. We project that the completion of our value-add initiatives will positively impact our leverage levels by almost a full turn and allow us to take a meaningful step towards achieving our long-term target of mid-7x net debt to EBITDA. This powerful value-creation program for our shareholders demonstrates that our investment strategy goes far beyond owning the right assets. We know how to unlock value through operating and managing our communities as well.

To that end, the performance of our recently acquired nine-community portfolio has exceeded our expectations. On a year-over-year basis, we've driven revenues by 6% and reigned in expenses by 2%, which has generated NOI growth of 12% for the portfolio. This outperformance underscores our investment thesis and can be attributed to the on-boarding of these communities on to our revenue management platform, the elimination of property management and efficiencies and investing in the people at these communities. We believe that there are additional value to unearth, specifically through the value-add initiative. Over half of the properties in this nine-property portfolio are included in Phase 2 of our value-add initiatives, set to start later this year. As always, we will continue to look for ways to expand margins and boost the NOI in this portfolio. We are being disciplined and judicious in our use of capital and currently believe that the greatest value is being derived from this value-add initiative. However, we continue to evaluate capital recycling opportunities. While we did not disclose of any communities in Q1 and we have not provided guidance around this initiative for the year, we will continue to monitor the markets and we will selectively and opportunistically recycle capital out of existing communities, including our Class A assets and into new communities that meet our investment criteria.

Now I'll turn the call over to Farrell for an in-depth discussion of our markets and value-add projects, and then to Jim to review our financial results. Farrell?

Thanks, Scott. We continue to drive rent growth and maintain high occupancy levels in the first quarter of 2018. Same-store revenue increased 2% year-over-year, while operating expenses were up 2.1%, driving year-over-year same-store NOI growth of 2% during the period. This quarter was unique for our market as the southeast of the United States experienced one of the harshest winters on record, and I want to recognize our teams on the ground for their effort. The weather caused a significant decrease in walk-in traffic at many of our impacted communities and increased several expense categories. The utilities were up 5.6% or $120,000 due to the unprecedented conditions, with markets like Atlanta, Baton Rouge, Jackson and Raleigh experiencing higher instances of freezing conditions and storms. Contract services were up primarily due to additional snow removal costs. And our causality expenses, we had none in Q1 of 2017, increased to $80,000 due to the repair of frozen water lines.

Our same-store NOI growth was propelled by several of our core markets. We saw a strong top line performance in Atlanta, Columbus, Orlando, Asheville and Huntsville, all delivering same-store revenue growth north of 5%. Further, we saw double-digit NOI growth in Atlanta, Oklahoma City and Columbus. This outperformance shows the continued growth opportunity in our core markets. These increases were the result of a 50 basis point increase to our same-store occupancy, which was 94.4% at the end of the quarter.

Focusing on our larger markets, Atlanta continues to outperform and is benefiting from a thriving job market population growth. Our same-store properties in this market had revenue growth of 6.5% and a reduction of expenses of 6.6%, generating NOI growth of 14%. As we mentioned, it appears Oklahoma City bottomed out 12 to 18 months ago and is now starting a slow rebound. To boost occupancy, we reduced rents slightly, and we're successful at increasing occupancy by 350 basis points over last year. The result was an increase in revenue of 2.6%. Expenses decreased significantly as we had less units to turn as compared to last year, producing NOI growth of almost 14%. Louisville saw a revenue increase of 0.5%, much of this can be attributed to the start of the value-add project at our Jamestown community, where we took units offline for renovations ahead of leasing season. Expenses were down 2%, generating NOI growth of 2.5%.

Memphis had revenue growth of 3%, but we experienced some large real estate tax reassessments, which increased operating expenses by 5.1%, resulting in NOI growth of 1.5%. In Raleigh, we increased rent per occupied unit by 1.7%, but this was offset by occupancy decline of 1% year-over-year, from 96% last year to 95% this year, resulting in flat revenue.

Most of the occupancy impact can be attributed to the Aston community, which dropped 300 basis points from 97.4% to 94.3%, as there was a property and lease-up in the submarket as well as an overall decline in traffic across the market due to weather conditions. As we stated on our last call, community in Orlando, located in the Millenia submarket has delivered consistent results even with significant supply pressure.

Later this year, a new community, directly adjacent to ours, will begin lease-up, and accordingly, we may see some softness as this community -- at this community in the second half of 2018. Similarly, Greenville and Charleston continue to be challenging markets. In Greenville, revenue fell 3.5% year-over-year, while revenue diminished 1.9% in Charleston. Our communities in these markets are Class A and are competing directly with new construction. Despite Q1 performance, we believe both these markets are still on track to deliver 1.5% revenue growth in 2018.

Turning to investment activity. In addition to the closing of the last 2 communities in the nine-community portfolio acquisition, we purchased 2 communities in Columbus during the quarter, bringing our market exposure as a percentage of total units to 8.6%. While we updated you on 1 acquisition during our previous call, we subsequently acquired a 235-unit community on February 27 for approximately $23 million. This community is situated in the Great Hilltop submarket of Columbus and is conveniently located between several employment hubs, including the Rickenbacker International Airport in the business district in downtown Columbus. The community was 99.2% occupied at quarter-end with an average rent of $881. These 2 communities were purchased at a blended 5.9% economic cap rate.

As we signaled in the past, we believe the Columbus market has strong fundamentals, evident by Q1 rent growth for the overall market of 3.1% and will continue to be opportunistic as we capitalize on the scale we have built there.

Lastly, I want to share more details around the value-add initiatives. Echoing Scott's statement our value-add projects are going as planned and yielding the returns we projected. As of March 31, we completed 236 units of 1,566 units in Phase 1 at an average cost of $9,276 per unit. We are re-leasing units with an average monthly rent premium of $154 per unit over the expiring lease, representing a 20% return. We expect to complete Phase 1 by the end of 2018 and are on track to begin our projects in Phase 2 pipeline of nine-communities aggregating a total of 2,752 units later this year. We expect to complete our Phase 2 projects by the end of 2019.

With that, I'll turn the call over to Jim for an update on the financials.

Thanks, Farrell. For the first quarter of 2018, net income available to common shareholders was $3.4 million, down from $4.1 million in the first quarter of 2017. Core FFO grew by $2.6 million to $15.6 million for the quarter ended March 31. Core FFO per share was $0.18, flat year-over-year, primarily due to the timing of the acquisition of the nine-community portfolio and the related equity offering that occurred last September. Adjusted EBITDA for the quarter increased to $23 million, representing a 17% increase year-over-year. This shows that we are beginning to see the results of the portfolio transformation that we executed in 2017. We reported same-store NOI growth of 2% and revenue growth of 2%, with property level expenses increasing 2.1%. While this is not the growth we posted in previous quarters, it is in line with our projections and stated guidance for the quarter, and as both Scott and Farrell mentioned, it was impacted by adverse weather conditions impacting leasing traffic, higher contract services for snow removal, higher utility expenses and casualty expenses resulting from repairs to frozen pipes. It's not too often that Jackson, Mississippi, has 10 degrees in the middle of January.

Turning to our balance sheet. We closed Q1 with 56 properties and total gross assets of approximately $1.7 billion. This marked a 9% increase in gross assets sequentially and can be attributed to the close of the remaining properties in our nine-community portfolio acquisition as well as the acquisition of 2 additional communities in Columbus, Ohio. This increasing growth assets increased our total debt to $903 million, bringing our total debt to total gross assets to 53.5%. From a net debt-to-adjusted-EBITDA standpoint, our pro forma leverage was 9.4x after adjusting for timing of acquisitions and the start of the value-add project. As of quarter-end, our debt is approximately 96% fixed, with no significant debt maturing until 2021.

Keeping our eyes on the longer term, we continue to believe that the incremental NOIs and the value-add initiatives will continue to propel our deleveraging efforts. We remain prudent and proactive in improving our capital structure, and we remain focused on organically growing our NOI. As Scott and Farrell stated, our 14 value-add projects offer significant opportunity to unlock value and deliver return for shareholders. These projects remain on schedule to deliver the $9 million of incremental NOI and have a projected return of approximately 20%. As of March 31, our unencumbered assets as a percentage of our growth assets was 40.3%. From a total NOI basis, our unencumbered assets represent 39.2% of our portfolio. This information is now included in the debt summary page of our supplement.

While this is slightly down sequentially due to acquisitions within the quarter, we remain committed to our long-term goal of increasing our unencumbered assets.

With respect to guidance, we are reiterating our guidance for full year 2018. We expect core FFO per diluted share to be in the range of $0.74 to $0.79 and expect organic same-store NOI growth to be between 3% and 4%. So remember, we commenced value-add projects in the 5 communities this quarter. We believe we will see some quarterly operational fluctuation due to the occupancy impact from these renovations, but view these near-term impact is negligible compared to the long-term benefit of the projected rent premiums. We expect most of the impact from our value-add program to be realized in 2019 and beyond, subsequent to the completion of all 14 projects. To view our full set of guidance metrics, please review our first quarter supplement that can be found in the Investor Relations section of our website.

With that, Scott, I'll turn the call back to you.

Thank you, Jim. As Jim stated, while we may realize fluctuation in market fundamentals on a quarter-to-quarter basis, we believe our underlying investment thesis is validated by a positive rental demand trends. The affordability that renting provides, combined with the housing shortage throughout The United States, continues to benefit our apartment communities. Earlier this month, The Wall Street Journal reported that as a result of the housing shortage, price homes in The United States rose 6.2% in 2017, double the rate of income growth and 3x the rate of inflation growth. These fundamentals inherently make renting more cost effective, with 66% of renters claiming to rent for financial reasons according to Freddie Mac survey conducted this past January. As further evidence that we are strategically located in the right nongateway market, during the first quarter, our markets outperformed international average and the gateway market average, in both population and job growth, on a year-over-year basis. We are confident that the fundamental drivers of this growth will continue to provide the ability to increase rents and drive long-term shareholder value. We continue to invest in our communities, the technology and employees to make sure that IRT is taking advantage of these dynamics.

I think, at this time, operator, we would like to open the call for questions.

(Operator Instructions) And our first question will come from the line of Austin Wurschmidt with KeyBanc Capital Markets.

Just wanted to focus on the revenue growth guidance. Clearly, you suggested there were some softness due to the winter storms in the first quarter related to the traffic. But curious if you can give us some metric and help us understand the trends? Where is occupancy today versus quarter-end? And what have you seen in new lease rates since the first quarter as well to kind of give some comfort that the reacceleration, I guess, is underway?

Yes, Austin, it's Farrell. I mean, we're slightly better than where we ended the quarter, in terms of occupancy, and we're seeing a significant amount of new traffic that is converting into leasing. On a blended basis, our renewals are right around 3% for new and renewal leases. So we think that's positive. And at 94.4% quarter-end going into strong leasing season that we think there is pent-up demand, we're pretty optimistic.

And we said -- you said new and renewals were 3%. What was that during the first quarter?

About 1%, blended.

On new. Blended? Okay.

Yes.

And then I wanted to touch on -- as you guys think about the priorities related to external growth, your value-add initiatives and managing the balance sheet, can you just help us understand how you'd rank those? Clearly, you were opportunistic with an acquisition this quarter, but ramped leverage fairly meaningfully, I guess, with the intention of bringing that down through disposition. But can you help us understand how you'd rank those priorities, and then can also touch on dispositions here in a minute as well?

Sure. I would rank value-add first. I think if you think about $9 million of incremental NOI growth, if you cap that at a reasonable level, you're generating $150 million to $170 million of value for an initiative that's going to cost us something less than $50 million to complete. So there's real value creation within that program. It also goes hand-in-hand with the balance sheet because that additional NOI obviously helps to deleverage the net debt-to-EBITDA ratio or to bring that down. I would disagree with you a little bit that we ramped up leverage meaningfully. Leverage was reduced or lower, I should say, because of the equity that we raised in anticipation of acquiring these properties and that equity was used to paydown the debt in the interim until we closed on the assets. So leverage really has not increased that much. It's really just because of the timing and the benefit we got at year-end by having that equity used to retire the debt, again, while we were awaiting for the acquisitions to close. And then after that, I think, the third thing would be continued growth through acquisitions. As I stated, we have been disciplined. We're not going to go out and do dilutive equity offerings just to grow for growth sake. If we -- if there is a time when we can issue shares in an accretive price, and we can acquire assets that will then be accretive to our earnings, we will take advantage of that. But in the meantime, we're focused on increasing or improving the portfolio that we have, generating increased returns through that improvement and to continue to manage the balance sheet.

Appreciate that, Scott. And I guess I was referencing more the quarter-to-quarter sequential change in leverage. Clearly, on a year-over-year basis, you're in line with where you were a year ago. So that's what I was referencing there in terms of the leverage change. Lastly, just on dispositions, clearly, you said you're evaluating the market. Can you just give us a little bit of an update on what you're seeing in the market? And how we should think about the timing of future dispositions as you think about the capital recycling initiatives you talked about in the past?

The market for acquisitions is very competitive, as we all know, so that goes hand-in-hand with the sales. I mean, obviously, we would -- we're looking to take advantage of this aggressive market on the sales side, but at the same time, we want to be able to redeploy that capital in an accretive way. So we're -- we have an active pipeline that we are consistently updating and reviewing and working on. We have identified a number of markets at the right time when we can redeploy the capital. We've identified a number of markets that we would be willing to exit. But we wanted to do it where it goes hand-in-hand with the sale goes hand-in-hand, I should say, with the acquisition. Because we are focused on everything, not just the leverage but we're focused on our payout ratio. And we all know that one of our goals is to bring that payout ratio down. So I don't want to shrink the company at this time just by selling assets without having the ability to redeploy that capital.

And our next question comes from the line of Drew Babin with Baird.

Starting off with Atlanta, you mentioned revenue growth was, I think, 6% or something like that year-over-year and expenses were down about 6%. Can you talk about what drove those expenses down considering that the winter was tough? I guess, I'm just curious kind of what item drove that?

Yes. Some of it was -- it was really across the board. The majority on the expense side savings across the board. I mean, some of it was in turnover and repairs and maintenance, but it really was reality taxes and insurance, basically almost every operating expense item is down slightly. And then on the rent side, it's just a really -- it's been a really dynamic market for us. And that's why we're -- there's a -- we're starting to see the benefit of the value-add, and we'll continue to see that throughout 2018.

Okay. That helps. And then talking about, I guess, Memphis, Charlotte and Greenville is 2 markets that were facing some new supply and were a little bit weaker. I guess, in those markets, despite the fact that fundamentals have been slowing and there's a lot of lease-ups in the market, have cap rates evaluations changed at all to reflect that lower NOI growth expectation? Or do you see things continuing to be solid as they had been there?

No. I think just given what Scott said about how competitive the marketplace is, you're still seeing -- we haven't seen any movement in cap rates in those markets.

Okay. And then I guess, lastly, just on the value-add projects. You mentioned that the Louisville asset, there was some units taken offline. And I guess, if it applies to the other projects throughout your portfolio, are you taking units offline for an extended basis at all of them? Or there are some assets where you are just doing renovations on term or maybe you have a little more downtime than you would typically have?

Yes. That's exactly right. I mean, it's taking about 2 weeks to turn to completely renovate a unit versus 5 to 7 days when doing natural turn. In Louisville, Jamestown and South Terrace, we just wanted to -- we're doing a pretty heavy marketing campaign, and we wanted to have units available that were renovated as the traffic came in to rent them. It's a managed process. I mean, we're looking at every property we're doing renovations in and managing how many units come up for renewals and how many we want to renovate and how deep the market is.

And the next question comes from the line of Brian Hogan with William Blair.

Question on the 9 properties. You had 12% NOI growth and you said you acquired them for, like, -- and then kind of bridge that into the Columbus properties where you got 5.9% cap rate purchase price. I guess, I assume you're going to say you're going to get the NOI growth and value-add initiatives there. What about the cap rates after those value-add initiatives? Because 5.9% is lower than your current [indiscernible].

Well, on the HPI portfolio, the nine-property portfolio we purchased, we were performing stabilized cap rate after value-add at 7% to 7.5%. The 2 properties in Columbus, we have in -- they were purchased based on the existing cash flow. And so -- like we said in the past, we'll get them on our platform. We think we can operate them better. I think we can find some more efficiencies. We mentioned one of the properties we bought was 99.2% occupied, which leaves us to believe it they really weren't focused on pushing rents. And then we will evaluate if there are good opportunities to add to the value-add pipeline.

All right. And then your unencumbered assets are 40% of your portfolio or thereabout. Can we -- is there a time to think about little more change in the capital structure? Maybe do a -- like they do a rated bond offering? Or I guess, what are you thinking about using those unencumbered assets for?

Yes, I mean, that's exactly where our focus is intending on going. It is to get into the kind of the rated bond market. We're not there just yet, but we're certainly continuing to push in that direction. And probably the first step will be doing something with rated insurance bond potentially before kind of doing a broad investment-grade kind of situation, but we're moving in that direction.

And the next question comes from the line of Craig Kucera with B. Riley FBR.

Just want to circle on the value-add program. It looks like you spent about $2 million this quarter. How are you thinking about the cadence of spend for the year? And is your guidance inclusive of hitting all of your completions? Or is that really just a function of where you see a sort of more organic or market rent growth and NOI growth going?

Well, the pace is such we'll start picking up as we enter into the natural season in spring and summer where you have more leases rolling. Q2 is estimated around 300 to 350. Q3, we'll get up to 700 and then will scale back a little bit as the amount of leases expiring reduces towards the winter.

And as previously guided, it does include obviously hitting that -- completing those units and then re-leasing them at that leasing spread that Farrell mentioned of about $154 a unit or a 20% ROI.

(Operator Instructions) And our next question will come from the line of John Massocca with Ladenburg Thalmann.

So with Avalon Oaks already -- I'm assuming you are working on that transaction for a little bit. So was that already factored into your prior earnings guidance? And if not, how much of an impact did that have?

It wasn't a very -- it was factored in. It was relatively small impact. Obviously, it's in a nonsame-store category, so it doesn't obviously impact the same-store guidance. And for the year, until it's kind of on our platform and running for a period of time, it's a very small kind of earnings effect.

Understood. And then given your current leverage levels and -- do you think you have the ability to add incremental acquisitions without kind of matching with disposition proceeds or maybe even additional equity?

No. No, I mean, clearly, as I've stated all along, we are focused on bringing leverage down, not increasing it. So we would not acquire an asset through the use of -- all leverage. And in fairness, with our stock trading at what we believe is a real discount to NAV, I'm not really looking forward to issuing equity. So we're focused on the value-add program. We think that, that adds a tremendous value to the company, and when the timing is right, we'll grow through new acquisitions. But again, if we see the ability to recycle out of something and to replace that capital accretively, we will do that. But not go out and issue equity to grow or to just use leverage to grow at this point.

Sure, sure. That makes sense. And then kind of maybe shifting gears to the existing portfolio. Same-store repair and maintenance expenses were down, almost 20%. How much of that was in the quarter? How much of that was weather-driven? Maybe you're just not having the weather out there to be able to do some of the repair-type stuff. And how much of that was just related to not needing to do repairs this time around in the cycle versus last year?

I think, it's twofold. One, it's not needing to do the repair this year; and two, just lower turns happening at the properties.

Okay. So there's more lower turns rather than anything where the weather was such that you couldn't have people go out and do certain repairs, and that's going to kind of maybe come back up in 2Q, where some of these things got delayed?

Yes, well, we -- I mean, we always see on the slight uptick in repairs. Obviously, once the weather gets better, we always budget for that. But when you look at kind of Q1, there were some repairs last year that needed to be made, and they did not need to be made this year.

Thank you. And I'm showing no further questions at this point. I would like to turn the conference back over to Mr. Scott Schaeffer for any further remarks.

Well, thank you, everyone, for joining us today, and we look forward to speaking with you next quarter. Have a good day.

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