Mid-America Apartment Communities Inc (MAA) 2003 Q3 法說會逐字稿

Good morning ladies and gentlemen and thank you for participating in the Mid-America Apartment Communities third-quarter earnings conference call. At this time, all participants are in a listen-only mode. The Company will first share its prepared comments followed by a question and answer session. As a reminder, this call is being recorded. At this time, we would like to turn the call over to your host, Mr. Eric Bolton, CEO. Mr. Bolton, you may begin.

Thank you. Good morning. This is Eric Bolton, CEO of Mid-America Apartment Communities. With me this morning are Simon Wadsworth, our Chief Financial Officer; Al Campbell, Director of Financial Planning and Tom Grimes, Director of Property Management. Before we start this morning, I need to remind you that as part of our discussion, we will make forward-looking statements. Please refer to the safe harbor language included in our press release and our 34 (indiscernible) filings in the SEC which describe risk factors that may impact future results. We will post a copy of our prepared comments as well as an audio copy of this call on our website. With that introduction, let's get started.

Mid-America had a good quarter. Before the non-cash accounting adjustment associated with our preferred stock refinancing, funds from operations equaled last year's third quarter performance at 69 cents per share. On the year-to-date basis through three quarters before this non-cash accounting adjustment, FFO per share has increased 2.4 percent over last year. The quarter's performance was influenced by a focus initiated in late summer to accelerate activities surrounding apartment turn and get-ready processes with a goal of locking in a solid occupancy base before we hit the slower holiday and winter leasing months. We're pleased with the results of this initiative and the solid improvement in occupancy that our property management group was able to achieve. While there was some short-term pressure on operating expenses for the quarter as a result of this push, we're confident that the improvement in occupancy sets us up for a much stronger revenue performance over the last two quarters. We expect to see operating expenses trend down in the fourth quarter, both as a consequence of normal seasonal patterns, but also because we have locked in a higher level of occupancy and costs will drop.

Through a combination of generating steady operating results, executing a number of opportunistic refinancings and successful deployment above existing and new balance sheet capacity in high-growth markets, we have continued to improve the balance sheet, flexibility, fixed charge coverage and importantly, our capacity to strengthen dividend coverage. We expect to continue to make steady progress over the next year and feel good about the position of our portfolio and balance sheet as we look towards market recovery in 2004.

Mid-America continues to generate one of the stronger and more stable AFFO performances for the apartment sector. The result is driven by several factors unique to Mid-America. Our strategy is focused on apartment product that appeals to the largest segment of the rental market, both in terms of submarket (ph) location, as well as pricing. Our portfolio strategy diversifies capital across large, middle and small-tier cities over the stable demand region of the southeastern U.S., thereby providing a stable platform over all phases of real estate and market cycles.

And finally, our focus on company culture built around aggressive property management operations, along with the conservative approach to financing growth, work to ensure that shareholder value is well protected. Mid-America shareholder returns have exceeded the NAREIT apartment index on a year-to-date basis and have also outperformed this index on a one-year, three-year and five-year comparison. We believe that our owners will continue to be rewarded as we remain focused on strengthening dividend coverage and conditioning the portfolio for stronger and diversified internal growth, along with disciplined new external growth. With that introduction, I'd going to turn the call over to Tom to give you insights on our property operating results for the quarter.

Good morning. With the traditionally slow winter months approaching, we made a conscious decision to take steps to increase portfolio occupancy. This effort was twofold. One, drive traffic to the property by increasing marketing efforts and two, turn units more quickly to ensure that we had a large number of high-quality market readies available. Our efforts were successful. Traffic levels were 4.3 percent higher than the third quarter of 2002. More importantly, we handled the traffic more effectively on-site, we produced 18 percent more leases this quarter than in the prior year. As a result, occupancy increased 80 basis points from the same time a year ago to 94.7 percent, a twelve-month high and up 2.1 personage points from the second quarter.

Same-store revenues were down 1.6 percent versus a year ago, but up 74 basis points on a sequential quarterly basis. The primary reason for the year-to-year performance was an increase in vacancy loss. Concessions were necessary to assist with the occupancy push, but remained constant with the prior year. Average rent per unit remained stable, essentially flat with last year. This leaves the pricing of our portfolio in tact and well positioned for the future.

The cost of this occupancy increase is reflected by expense performance this quarter. We feel short-term expense trade-off will create revenue benefits through the next two quarters. As mentioned in earlier calls, our lease expiration management practices limit our exposure to move-outs in the slower winter months. Through the end of the year, each month has fewer than 6 percent of our total leases expiring. We believe the higher occupancy, combined with our intensive lease expiration practices, will provide a stable foundation for revenues in the next two quarters.

Total property operating expenses, which excludes taxes and insurance on a same-store basis were up 6.7 percent for the quarter versus last year. This was primarily driven by the marketing and unit preparation cost. This is a direct result of our choice to aggressively push occupancy. We feel comfortable that we will see a return to our traditionally strong expense performance in the fourth quarter of this year. This is the first time in three quarters that we have posted a year-to-year increase in property operating expenses. Year-to-date, our same-store property operating expenses are up just 1.75 percent. This strong year-to-date performance is a result of our maintenance efficiency program which is outlined in the previous call which benchmarks per-unit expenses on key repair and maintenance activities.

Our revised resident retention program, community awareness programs and early renewal practices continue to show very good results. Resident turnover for the quarter on a same-store basis was down 1.9 percent versus the same quarter a year ago. This marks the sixth straight quarter that we have seen year-over-year turnover trends show a reduction. We feel this improvement is especially important in competitive markets and is particularly significant, given the robust home buying environment. In highly competitive markets, we will aggressively compete on product quality, presentation and with pricing or concessions when necessary. We feel that (technical difficulty) the long-term trade-off, the lower customer credit quality to try and capture short-term occupancy boosts. Our net delinquency for the quarter increased to 1.43 from 1.15 a year ago. We are comfortable that this is a result of the challenges individuals are facing as they navigate the tough jobs environment, as opposed to a deterioration of our credit standards. In fact, our credit scoring policy is more conservative than at any time in our history and we rejected a larger portion of applicants -- 19.7 percent in the third quarter of this year, versus 18.3 percent in the same quarter of last year. Though difficult to do in these tough market conditions, we feel standing firm on the credit worthiness of our residents is critical. We anticipate that the rollout of our new property management system will begin in the fourth quarter. This system will speed the information flow, allowing us to manage our operations more closely and streamline data input on site, which will result in increased productivity, allowing our property personnel to spend more time working with our customers. Al?

Our diversification across large, middle and smaller-tier markets continued to serve us well during the third quarter, producing relatively stable overall revenue compared to the prior year, continued improving trends compared to the second quarter of this year. Our large markets continue to be our most difficult comparison to the prior year with a 5.5 percent revenue decline, while our middle markets performed essentially at the portfolio average of a 1.6 decline and our smaller-tier markets produced essentially flat revenues compared to the prior year.

However on a sequential quarterly basis, our large markets began to show improvement as a whole at .7 percent revenue growth, while our smaller tier markets continued to produce solid growth, 2.1 percent. Our midsize market revenues did decline slightly from the second quarter of 0.6 percent, but occupancy levels at the end of September were 2.2 percent above the levels at the beginning of the quarter, supporting expectations of improved performance in this group for the fourth quarter. The focus on occupancy improvement during the third quarter was successful throughout our entire portfolio. Our large, middle and smaller-tier market group all began the fourth quarter with occupancy levels well above the prior year and the prior sequential quarter.

Atlanta and Dallas are still our most challenging markets as high concession levels and selective rent reductions continue to be necessary. Both markets showed a reduction in revenues compared to the prior year -- Atlanta at 9.3 percent and Dallas at 3.9 percent. However on a sequential quarterly basis, both markets showed improvement with a combined revenue increase of 1 percent and much stronger occupancy going into the fourth quarter. Atlanta grew occupancy 3.6 percent on a sequential basis and Dallas 4.2 percent.

In general, apartment demand is on the way up, while the level of new supply is on the way down in both Atlanta and Dallas, leading to expectations for more balanced conditions for the upcoming year. Occupancy and rent levels are expected to remain stable through most of next year with initial improvement coming from waning (ph) confessions as these markets improve.

In our middle market group, our strongest performer continues to be Jacksonville, which grew revenues an impressive 6.1 percent over the prior year. We expect essentially balanced conditions to remain in this market, producing continued solid performance well into next year. Revenues in Memphis, our largest market, were down 2.3 percent compared to the prior year, mainly related to increased concessions necessary to strengthen occupancy levels going into the fourth quarter.

Occupancy did improve 1.3 percent in the second quarter, ending at 93.5 percent. The conditions in Memphis are generally expected to improve with the economy (indiscernible) supply and demand are expected to remain essentially in balance.

Greenville, another mid-tier market, showed particular improvement during the quarter. Although revenue comparison to prior year remain difficult at 9.6 percent decline, occupancy levels improved more than 10 percent in the quarter, ending at 98.4 percent. We should produce stronger comparisons for the fourth quarter.

The solid performance of our smaller-tier markets was led by Jackson Mississippi, which produced 4.3 percent revenue growth compared to the prior year; Columbus, Georgia, 3.4 percent growth and Huntsville, Alabama, which produced 3.1 percent revenue growth. We continue to expect stable results as a whole from our smaller-tier markets well into next year.

Our portfolio remains in excellent condition, reflecting our continued commitment to protecting shareholder value. Capital spending through the third quarter is on track and is expected to end the year with total recurring expenditures of about $410 per unit, or $13 million and with expenditures for revenue enhancing projects of about $180 (technical difficulty) or $6 million. There is no significant pressure to increase this spending level and we expect similar capital outlays for 2004.

We have begun to see some softening in acquisition pricing in terms, making more deals attractive. At the end of the quarter, we closed on Los Rios Park, a 498 unit high-quality property located in the growth corridor north of Dallas. The purchase price represents a 7.25 percent cap rate on the first year's suppressed cash flow with expectations for that yield to increase 100-150 basis points over the first few years of investment as the Dallas market rebounds and management initiatives take effect. We also have two properties currently under contract with one expected to close before year-end and the second expected to follow early next year as part of our joint venture initiative. Both properties are located in our target higher growth markets of the Southeast. Simon?

Overall, we're well pleased with our second quarter. At 69 cents, our FFO per share before the 28-cent adjustment for the preferred stock issuance cost was at the high end of our forecast of 67-69 cents per share. Lower debt costs, bonuses and administrative expenses that (ph) we planned and quicker closing of our acquisitions offset the additional expenses we incurred for our occupancy push. As we announced in our second quarter release and conference call, our forecast range for third quarter FFO did not include the impact of EITF D-42. On July 31st, the SEC issued as staff policy bulletin which requires that original costs of redeemed preferred stock be charged against net income available for common shareholders, thereby impacting earnings per share. Although this is a non-cash item, we've adopted this in our calculation of FFO and FFO per-share, and in line with most analysts, we have excluded it from our calculation of AFFO. The total amount of the adjustment, $5.98 million, or 28 cents per share, represents the original issuance cost of the $148 million of preferred stock that we redeemed in August. The real economics of this transaction are that we estimate that this preferred refinancing more favors $874,000 per year in dividends.

During the quarter, we funded two significant investments with direct placement of 1.365 million common shares with net proceeds totaling $39.4 million. Our transaction costs were minimal and we were able to time the stock sales coincident with our acquisitions. The average net proceeds after expenses were 28.87 (ph) per-shares. The sale price was set at a 2 percent discount for trailing 10-day average pricing. This compares to our purchases of a total of 1.8 million shares three years ago at an average price of $22.54 per share, giving us a positive arbitrage in our stock transaction of $6.30.

We consolidated onto our balance sheet just over $79 million of debt as a result of the purchase of Blackstone's two-third interest in our joint venture. Under the terms of EITF 98-1, we are required to mark this debt, which has an average interest rate of 7.6 percent, to the market rate, which is closer to 2.5 percent. Based on the net present value calculation, this results in us booking a $3 million premium on the liability side of our balance sheet, which will be taken into income over the period until the debt is refinanced next year. This will increase our net income and FFO 6 cents a share, or $1.4 million in the fourth quarter of this year, and a total of 7 cents a share, or $1.6 million next year, of which $1.1 million will be in the first quarter, $400,000 will be in the second quarter and $100,000 in the third. None of this income is cash and has no impact on the funding of our business or of our dividend. So we intend to disclose this amount in our quarterly report and back it out of AFFO.

We have a great opportunity to continue to make headway in reducing our interest expense. While next year we only have just over $70 million of scheduled debt maturities, we are planning to refinance a total of $165 million of debt, including the $79 million to form a joint venture debt I just mentioned. We have locked the rate on $40 million of this through a forward swap. Based on the current forward yield curve, it should be possible for us to interest realize interest savings of $4 million a year on a full year basis once all of these financings are complete with the full benefit being realized in 2005. These savings will help us to offset next year’s expected increase in variable interest rates. We're in the final stages of negotiations with Fannie Mae to increase our credit line from $550 million to $800 million, which we plan to use for much of our 2003-2004 acquisitions and refinancings.

Our fixed charge coverage continued to strengthen on a year-over-year basis, rising to 2.42 from 2.36 and our debt service coverage also improved, rising to 2.37 from 2.31. We ended the quarter with debt at 49 percent of total market capitalization, a low level for a REIT without exposure to the risks of development. Our average interest rate is 5.5 percent, down from 6.04 percent a year ago. We continue to manage our balance sheet prudently. We have limited our interest rate risks, we're having fixed, swapped, capped or forward swapped 85 percent of our debt.

We have modified our forecast of FFO to include the projected increase resulting from the amortization of the adjustment to the value of the acquired joint venture's debt. Otherwise, our forecast remains unchanged. The result is to increase the FFO forecast for the fourth quarter by 6 cents to a range of 75 cents to 77 cents per share, and for next year, a range of $2.89 to $2.97. We believe that the first quarter of next year's FFO will likewise increase by 5 cents to a range of 74 cents to 76 cents per share. Our key assumption is our relative same-store growth rates. After the increased activity of last quarter, we're projecting our expense performance for the fourth quarter will return to a more normal level and that our revenues benefit from the occupancy push. This will cause our same-store NOI growth to be down slightly, around 0.5 percent compared to the same quarter a year ago, and for the full year 2003, we're projecting it to be down just over 3.5 percent to about 3.6 percent.

Our projections for next year assume that same-store NOI will return to the same level of 2002, indicating growth of 3.6 percent. We have built in the likely acquisition of another property in the fourth quarter and completing two more acquisitions with pro (ph) holdings to finish our $150 million joint venture by the end of the first quarter of next year. We're carrying the capacity to make around $50 million in further investments which we have not included in our base forecast. Our dividend yield at 7.5 percent was proven to be attractive to investors and compares to an average yield for the sector of 6.5 percent. If we're able to achieve the upper end of our forecast next year or if we make additional acquisitions, AFFO is projected to exceed our dividend towards the end of 2004 or early 2005, and obviously a key to this are anticipated improvements in the apartment markets driven by renewed job growth. Eric?

We're pleased with the progress to date on the strategy we laid out a year ago during what has obviously been a challenging operating environment, Mid-America's unique portfolio focus and operating capabilities has generated one of the best performances of the sector. We've made progress over the year on improving dividend coverage and positioning the balance sheet and the portfolio for more robust earnings growth as market conditions improve. We will continue to maintain a well diversified portfolio spread across large, middle and small tier markets in the high-growth southeastern region of the country. Our acquisitions program has successfully deployed capital in a number of high-quality investments and high-growth markets over the course of the year and we remain alert for additional opportunities. Our growth platform is in place and achieving success. As market conditions improve, our existing portfolio of properties coupled with the new investments to date position Mid-America for more robust earnings performance, accelerated growth and net asset value and higher levels of dividend support. That is all we have in the way of prepared comments, so John, I'll turn it back to you for any questions.

(Operator Instructions). Paul Puryear, Raymond James.

Thank you. Good morning, guys, good quarter. Eric, could you talk a little bit further about repositioning some of the portfolio and specifically, the markets that you're targeting and sort of the objective there -- where you want to get from sort of an asset waiting?

Really at the start of this year when we really started looking at where we wanted to head we head, we have -- if you took our capital and looked at how we diversified over the large, middle and small-tier markets, we had about 40 percent of the capital in small markets, about 40 percent in mid-tier markets and about 20 percent in our large tier markets. The acquisition is completed to date. Obviously, we're tending to focus on the large markets, such as Dallas and Atlanta. We are also looking at some of what we feel to be some of the more robust midsize markets, such as Nashville and Jacksonville. And ultimately, where we would like to get to is a more equally weighted portfolio that I'm going to -- we don't have a specific target in mind, but I would say certainly kind of a third, a third, a third, in terms of large, middle and small, for lack of anything more definitive right now, would certainly be a target for us.

I do believe that you guys are as aware as we are what the demographics and what all the indications are for the apartment sector for the next 10 years or so. We believe it will be important for us to have more capital in some of these higher-growth markets. We like the small markets of course and we like the stability that they bring to our performance, so we certainly are not talking about abandoning them. But we do think that with a little different kind of a diversification, that we will be in a better position to create the kind of internal growth that we'd like to see in the next five years.

Okay thank you, that helps. Are there any markets, new markets on the radar screen?

No, not really. We've taken a hard look at some things in South Florida this past year. We've made a run at a number deals down there. But as you know, pricing is just incredibly rich down there and we just didn't feel like we had -- it worth us, the risk right now frankly. We would have to overpay in our opinion to get into that market down there right now, and we don't really go that far south with our management team. And so I don't expect to see anything happening down there at this point. But, no, there's no real new markets. We would like to do maybe a little bit more in the North Virginia area. We have one in that market there and perhaps a little bit more in the Raleigh area. But we like the markets that we're in and nothing real new on that front that I could point you to.

As far as a cost of capital versus where you can buy properties today, how do you look at that? Because the cap rates obviously are extremely low and the spread that you think you're making. Obviously, you're making a spread over

Clearly, what we do is, first of all, we look at our cost of capital on an internal rate of return basis. But also what we do is we have a test we call a burn test, which is after one of our former directors, Jack Byrd (ph). And what we're looking at is accretion in AFFO two or three years out from making the investment. And so that is in itself, if it were built, is based on the current market price at the spark (ph). So that (indiscernible) take into account also of course current pricing on debt and preferred, and that is -- we run that rigorously with each transaction that we look at, and that basically drives the investment decision.

I'd add to that, Paul, ultimately, really it comes down to three decisions that we make whenever we're looking at any capital deployment. First and foremost, as Simon mentioned, we underwrite to an internal rate of return target that we feel like we have to achieve on any capital deployment, and we feel like that mid-teens kind of return is something that our shareholders long-term expect from this kind of investment in Mid-America. We have the burn test that Simon has alluded to and there's a certain minimum earnings accretion per share that we have to achieve within two or three years out from the investment. And quite frankly, the other thing that we're very focused on right now is we absolutely will not put capital out in any way, we will not raise any capital in any way if there's any current dilution associated with it. We're just very, very focused on the dividend coverage issue. And if there's anything that we would do, in terms of capital deployment that would be dilutive to current earnings, we will not do it.

One more question. On the recurring CapX that is on the press release, I mean, it is up pretty dramatically if you compare the quarter and the year to last year. Could you just comment on that?

It is a timing issue. We have historically always spent roughly $400 in what we call recurring and $200 per unit in what we call revenue enhancing, so roughly $600. It is a timing difference between this year and last year. We'll end this year right at $600 a unit, just like last year.

Okay, very good. Thank you.

At this time, there are no further questions in the queue at this time. I'd like to thank everyone for joining the conference today.