RMR Group Inc (RMR) 2018 Q3 法說會逐字稿

Good day, and welcome to the RMR Group Third Quarter 2018 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Tim Bonang, Senior Vice President.

Good afternoon, and thank you for joining us today. With me on the call are President and CEO, Adam Portnoy; and Chief Financial Officer, Matt Jordan. In just a moment, they will provide details about our business and performance for the third quarter of fiscal 2018. They will then take questions.

I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on RMR's beliefs and expectations as of today, August 8, 2018, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause any differences contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website, rmrgroup.com, or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements.

In addition, we will be discussing non-GAAP numbers during this call, including adjusted earnings per share, adjusted EBITDA, adjusted EBITDA margin -- and adjusted EBITDA margin. A reconciliation of net income determined in accordance with U.S. generally accepted accounting principles to adjusted earnings per share, adjusted EBITDA and the calculations of adjusted EBITDA margin can be found in the news release we issued this morning.

And now I would like to turn the call over to Adam Portnoy to begin our quarterly review. Adam?

Thanks, Tim, and thank you to everyone for joining us this afternoon. For the third quarter of fiscal year 2018, which ended on June 30, we reported adjusted net income of $9.3 million or $0.58 per share, which represents an increase of $0.10 per share, or 21% compared to the same period last year.

Year-over-year results also generated growth across the company with solid increases in assets under management, revenues and EBITDA during the quarter. In addition to this quarter's solid operating results, we recently made good progress in our stated goal of diversifying our revenues and assets under management with the recently announced launch of the RMR Office Property Fund, our first real estate investment vehicle that is targeting private investors. This fund is a private open-end real estate fund focused on making investments in office properties throughout the U.S. Initially, the fund will primarily be focused on investments in middle market, multitenant office buildings located in core urban infill and suburban locations and non-gateway U.S. markets. The fund will be marketed to private investors with targeted annual returns of 8% to 10% through a combination of current income and long-term capital appreciation.

As part of the launch of the fund, RMR is committing $100 million and the Portnoy Family Office, or ABP Trust, is contributing $206 million of unencumbered office properties to the fund. We are hopeful that the fund will be well received by investors, who may appreciate the high alignment of interest we have with the fund, the middle market office focus is also something we have significant experience with and the fund's investment focus does not significantly compete with any of our managed equity REITs. We expect RMR's $100 million commitment to be utilized over the course of the next 12 months.

Through the use of this capital and a modest amount of leverage, the fund has an immediate $300 million worth of buying power. We expect the fund to reach over $500 million in total assets without the need to raise additional third-party capital. As this is a new business endeavor for RMR, we expect it to take some time to raise additional capital. But our long-term goal is that the fund may have at least $1 billion in gross assets under management within the next 5 years.

Turning back to our results for the quarter and activities at our client companies. From an operations perspective, our client companies had another strong quarter. On a combined basis, we arranged over 800,000 square feet of leases on behalf of our managed equity REITs for a weighted average lease term of just under 7 years and a weighted average roll up in rent of 2.3%. We also supervised approximately $21 million in capital improvements at our Managed Equity REITs during the quarter.

Some of the more noteworthy highlights across our client companies during the quarter include the following: ILPT reported strong results this quarter that included 218,000 square feet of leasing activity, which resulted in weighted average rental rates that were 34.5% higher than prior rental rates for the same space and weighted average lease term of over 11 years. ILPT saw same-property cash basis NOI increase 3.3% and announced the acquisition of a 240,000 square foot industrial property in the Miami market area for $43 million, its first acquisition since its January 2018 IPO.

SNH performed well during the quarter, with same property cash basis NOI increasing almost 1%, despite headwinds from its senior living portfolio. SNH remains focused on recycling capital by selling the last remaining property leased to Sunrise for a gain of approximately $80 million and selling 2 other communities, including a skilled nursing facility previously leased to Five Star for approximately $22 million in aggregate.

GOV saw same-property cash basis NOI increase by 5% and total leasing activity of almost 400,000 square feet, including 185,000 square feet leased to government tenants at a weighted average rent roll ups of over 4%. GOV also continued to deliver on its stated disposition plan, selling properties for aggregate proceeds of $129 million during the quarter resulting in total year-to-date dispositions of $149 million. At TravelCenters of America, nonfuel revenues increased by over $20 million compared to the same period last year, primarily due to growth in TA's truck service business.

Lastly, because RMR is releasing its earnings in advance to some of its client companies, I can only touch on some activities that have already been publicly announced. This quarter, HPT raised its regular quarterly cash distribution on its common shares by $0.01 to $0.53 per common share. HPT also amended and restated its $1 billion unsecured revolving credit facility and $400 million unsecured term loan. At Tremont, management continued building on its recent loan origination momentum by issuing loans totaling $33.3 million during the quarter. And after quarter end, Tremont announced the closing of $55.2 million in aggregate new loans.

As previously announced, RMR has agreed to waive its management's fee from Tremont for the 2-year period beginning July 1, 2018. We believe this waiver provides Tremont the time to fully execute on its business plan. In the long term, a stronger Tremont will be able to continue growing and in turn generate increased revenues for RMR. Management fee revenues from Tremont represented approximately $250,000 this quarter.

In closing, since June 30, 2017, we have formed 3 new client companies in 3 different real estate businesses, all of which may lead to enhanced growth in revenue and assets under management in future, and we continue to work towards finding additional strategic growth initiatives going forward. We also continue evaluating possible acquisition opportunities, though it remains important than any potential deal be complementary to our existing operation and generate accretive returns. As I highlighted last quarter, depending upon our use of capital in the coming months, we are also considering possibly returning some of our cash to shareholders in the form of a higher dividend rate.

I'll now turn the call over to Matt Jordan, our Chief Financial Officer, who will review our financial results for the quarter.

Thanks, Adam. Good afternoon, everyone. This quarter, we reported net income of $0.52 per share and adjusted net income of $0.58 per share. With this quarter's results reflective of $0.04 per share of separation costs for a retiring RMR executive and $0.02 per share of transaction costs associated with the formation of the RMR Office Property Fund. The growth in adjusted net income is primarily due to the impact of GOV's acquisition of First Potomac Realty Trust, or FPO, and the recent reductions in federal tax rates.

Management services revenues were $47.3 million this quarter, which represents a $2.7 million increase on a year-over-year basis, driven primarily by incremental service revenues from GOV's FPO acquisition. On a sequential quarter basis, revenues increased almost $800,000 due to growth in construction management fees as construction volumes at the managed REITs was up almost $6 million as well as TA nonfuel revenue increases driving incremental business management revenues. As it relates to incentive fees, we are only able to record revenue for incentive fees at December 31 of each year. If June 30 had been the end of a measurement period, we would have earned $47.5 million in incentive fees as it relates to the measurement period that ends on December 31, 2018, or over $95 million on a full year basis.

Total reimbursed payroll and other costs were $13.7 million, of which $11.7 million was reimbursed cash compensation and $2 million was equity-based compensation. Reimbursed cash compensation represented a 41% recovery rate, which was consistent sequentially and an increase of over 300 basis points on a year-over-year basis. The year-over-year increase was largely due to recoverable headcount increases, driven by GOV's acquisition of FPO.

Turning to expenses for the quarter. Total compensation and benefits expense was $32.7 million, which includes recurring cash compensation of $28.6 million, $2.3 million in share-based payments and $1.7 million of separation costs. Cash compensation of $28.6 million is an increase of $4.9 million on a year-over-year basis and $500,000 on a sequential quarter basis. The year-over-year increase in cash compensation is primarily attributable to GOV's acquisition of FPO and the related need for property level headcount additions as well as wage, benefit and bonus inflation. The modest sequential increase in cash compensation is attributable to headcount additions and continued growth in employee compensation.

Looking ahead, we expect this quarter's cash compensation to be a proxy for future quarters based on our current operations. I'd also highlight that annual RMR restricted share grants occur each September in conjunction with our fiscal year-end with 1/5 of all awards vesting when granted. Accordingly, consistent with prior years, our fiscal fourth quarter will include incremental RMR stock compensation expense. Last year, this expense was approximately $1 million, the majority of which is not recoverable.

As it relates to the RMR Office Property Fund, RMR will receive annual fund administration fees equal to 1% of the fund's net asset value and property management fees equal to 3% of rents collected from real estate owned by the fund. We are currently projecting the fund will have a nominal impact on fiscal 2018. And for fiscal 2019, the fund is expected to provide approximately $4 million of incremental service revenue and approximately $0.15 of net income per share on an annual basis. These projections represent our best estimates and remain subject to change based on variables such as fundraising, acquisition opportunity and RMR infrastructure cost required to support the fund. Finally, we ended the quarter with $280 million of cash on hand before considering our $100 million commitment to the RMR Office Property Fund, and we continue to have no debt.

That concludes our formal remarks. Operator, would you please open the line for questions.

(Operator Instructions) The first question comes from Mitch Germain of JMP Securities.

Adam, who is the target for fundraising for the fund? Is it high net worth? Is it family offices? Is it institutions? I mean, how do you foresee the next level of fundraising to take place?

Sure. It's all of the above, Mitch. It's family offices, its high net worth individuals, institutions. That being said, it's my belief that we will likely get more traction in the family office, high net worth RIA channel than the institutional channel in the first -- in the beginnings of the fund. There might be some smaller institutions that would come in. Of course, we're not going to preclude marketing institutions. I just think that the sales lead time for private equity or private investors in these types of funds is much longer. And I think that is being our first fund, I think we will likely pick up more traction from private investors, family offices than large institutions. That's not to say as time goes on that we won't eventually raise capital from larger institutions. I just don't think it's going to be a high hit ratio in the early goings of the fund. So that's how we're thinking about it.

And what's the characteristics of the property that's being contributed?

The 15 -- these 15 properties going in. They're all sort of -- they all sort of meet the characteristics that we've outlined for the fund in a sense they're middle market, they're bigger than 50,000 square feet. They're all multitenant office buildings. They're all located in what I've described as principally, non-gateway markets, but urban infill or close in suburbs locations, even around the Northern Virginia market, the Austin market, those are the 2 largest groups of properties. There are some properties around the Boston market. There are some properties, 1 property just outside Philadelphia. That's generally the characterization. They're all multitenant properties. I say that 2 of the properties are single-tenant properties, but they're principally multitenant, sort of, middle market office buildings that ABP or the Portnoy Family Offices owned some of these properties for several years, some of those properties were bought just in the last few years.

And was the contribution based on an independent appraisal?

Yes. A committee of RMR's Board of Directors made up of only the independent directors that are unconflicted with RMR or ABP hired a -- we negotiate basically with them, and we reached agreement, and they used -- they hired an independent third-party appraiser to help them in valuing the property. And that was the group -- that's how we went about the transaction. So yes, independent third-party helped an independent committee of RMR determine the value with us for those properties that go in. And just to recap, they're going in at an 8.5% cap rate.

That's helpful. And lots of independents there, I appreciate that. So I guess, if I look back a couple years when you created RMR, or when you took RMR public I should say, you wanted to grow your AUM in your -- the REIT fund, you were talking about an office fund, commercial mortgage. I mean, you've almost done everything that you set out to do based upon your original growth strategy. I know you said, hey, you may be using some of your cash either for dividends or acquisitions, I'm assuming that's another Asset Management type platform. But what is next for on the strategic front for RMR?

Sure. You're right. We've largely been telegraphing to the market for the last couple of years since RMR became public that -- getting into the commercial mortgage space, getting into the private fund space. Private fund space, focus more on the office side. The one other leg of the stool that we've talked about is really the securities management side of the business. We have a small securities management side of the business. We haven't really been able to grow that business much. I think that's the next part of the business that we are returning to, to see if we can try to figure out a way to grow that business. That said, of all the businesses that we've tried to launch and grow that might be the toughest. That's an industry that's still in a lot of decompression, lot of money flowing into passive strategies. And so it sort of ties into another thing you said, which is acquisitions. We haven't made much acquisitions. I can tell you we've looked at a lot of stuff, but we said, no, and walked away from many, many things. But the one area that I think we might make an acquisition or I could foresee it happening could be in the securities management side. There are some smaller to medium-sized players in the marketplace that they themselves might be looking for capital to grow or may have reached a sort of a limit in terms of how big they can get. And they could be interested in joining a larger platform like ourselves, and that could be an interesting possible acquisition. That being said, of course, acquisitions around other asset management platforms more generally we look at, but -- and we'll opportunistically look at those as they become available. But again it's a pretty high bar for us to execute on something more general like that. It'd have to make – it'd have to really be complementary, really add value, it'd also have to be dependent upon making sure it's very accretive to RMR to go forward. So that's sort of what's next, how I'm thinking about it.

(Operator Instructions) The next question comes from Bryan Maher of B. Riley FBR.

Two things. First, housekeeping. Matt, could you give us those incentive fee calculations that you put out there if the year were to end today? I think you said something about $40-something million and then $90-something million, can you walk through that again real quick?

Yes. The gross number would be $95 million for the full year, and that assumes SIR, GOV and SNH are paying a fee. No fee from HPT and ILPT. So the 47.5% number we quotes in the script was the half year projection.

Great. And then when it comes to the RMR Office Property Fund, it seems like a $1 billion should be pretty achievable one would think in 5 years, especially with the way you're getting off to start at. Does terms for the property management fees of 3% and 5% for the cost of construction or improvement, are those the same terms that you use for the externally managed REITs currently?

Yes. That's exactly the same terms. We specifically did not want to deviate from what we use for the equity REITs. So the terms are identical. The Asset Management fee, the 1% of net asset value is calculated differently. That would be equivalent to the business management fee, let's say, for the equity REITs, that's done differently and that's done differently principally because the way that fee is typically marketed or the convention for that type of fee in the private fund space is just different. So it's 1% of net asset value, net assets under management on the business management fee. But the property management and the construction management fee are identical terms to what it is with the equity REITs.

There is no incentive fee on that, though.

Correct. That's another big difference between this fund and the equity REITs. There is no built-in incentive fee. We spent a lot of time trying to design a fund that we thought would be marketable and attractive to private investors, to a large group of -- a large audience of investors. And we felt it didn't -- we didn't think including incentive fee was really going to work. And that's largely because we're talking about a core fund that's really shooting for high single digits, most funds -- competing funds that are core funds that are shooting for high single digits don't have incentive fees. And so we didn't want to have something that wasn't going to be consistent with the market when we launched our first fund.

And I'm surprised that the contributed assets currently have no debt on them. I mean, surely they didn't have -- surely, they had some debt on them before. Was it just paid off recently before they were contributed?

Those -- well, all -- the majority of the properties for the majority of the time we've owned them have not had any leverage. There has been some leverage on them over time, but there was no -- for the short period of time -- for the short-term before they were contributed, we didn't specifically repay any debt. They were all unencumbered several months before they went into the fund.

And then as far as what you're going to buy, and I see the description there and Mitch had some good questions on that. I was curious as to why you wouldn't also include some Class A urban office, let's say, for instance, like the Vertex headquarters in Boston, which was a good trade for SNH? Is it something that you might eventually move into? Or are you just seeing the returns on your current targets better than urban market where it might rely on an exit strategy to realize the upside?

Yes. It's a good question. To recap, the fund is focused on office generally. So there is no prohibition on what we can buy across the country that's office. What we've stated is our current focus is, what I call middle market, sort of bigger than 50,000 square feet, but less than $100 million in asset value. So think of a few hundred thousand square foot urban, close in suburb building that goes for tens of millions of dollars, not hundreds of millions of dollars. We think that today -- in today's market, those types of properties offer higher risk-adjusted returns than you can get in core downtown called Gateway City markets, New York City, Midtown Manhattan, I think great properties. It's just on a risk-adjusted return basis, given what we're seeing and again, we get the benefit of RMR well over 35 offices around the country, 1,700 properties we manage, $30 billion. We see a lot of different asset types, and we have a long history of investing in office properties. We think today focusing on the middle market, sort of focusing on -- sort of getting away from the top 4, 5 cities in America, when I say, you get away from the top 4 or 5 urban centers, we could be buying in those downtown markets away from those top 4 or 5 markets. But also close-in suburbs, I think there is a lot of good value to be had in buying these buildings at very good risk-adjusted returns. So that's just today -- in today's market what we plan to be focusing on over the next 12 to 24 months. 3, 4 years from now, we could be turning around, it could be a different market environment, and the fund because it mandates general office, we could turn around and say, hey, in this environment, we think it makes sense to be focused on Gateway core office towers. But today, that's not what we're primarily looking at.

And lastly from me, I'm sure, Adam, you kind of talked about this with friends and colleagues in family offices and other asset managers over the past, let's say, 6 to 12 months. Would you lead us to believe that the $1 billion is probably the conservative estimate? And if that's true, where do you really think that this could go to in the next 5 to 10 years assets wise?

Well, we wouldn't have gotten into this or committed capital or put this much contributed properties unless we believed that this could be a multibillion-dollar endeavor for us. It just won't be worth the energy, the effort and the money frankly, unless we believe it could be a multibillion-dollar enterprise. I don't know if the $1 billion is conservative. This is a new endeavor for us. We've had, as you've guessed correctly, in lot of conversations with family offices and in participants in that marketplace around this, we think we've designed something that will be attractive to investors, but until you are out there doing it, and it is our first fund, you really don't know. And I do know that the sales process can be long. And so maybe I'm – we're being conservative in saying $1 billion in 5 years, but I think if we at least get to $1 billion in 5 years, that's sort of minimum required to call this success. I want to temper everybody's expectation. We may not see an investment from a third-party in this fund for over a year. It may take that long for us to build up traction, but I do believe once you sort of build traction, once you sort of get to that $1 billion mark, and I just don't know how long it's going to take, it could take 2, 3 years, it could take 4, 5 years, but once you get there, I believe the velocity in the fundraising will pick up. You got to remember, it's our first fund marketing to private investors. Yes, we have a long track record in the public markets, and we are going to obviously talk a lot about that with the family offices, but it is our first fund. And so I'm just perhaps being somewhat conservative, but also trying to be realistic.

The next question comes from Owen Lau of Oppenheimer.

I do have one follow-up on the office property fund. I just want to get more clarity on the $4 million guidance and $0.15 net income per share next year. And I know it depends on the fundraising and acquisition opportunity, but can you also give more color about your assumptions of the fundraising effort? I know Adam just mentioned, it may take a year or so to ramp these things up. But can you give us more color on the assumption when you give out those $4 million and $0.15 guidance?

Yes. And just to be clear, those are incremental numbers. So as you can imagine we're earnings fees from those properties today that are being contributed. So the $4 million of incremental fees next year assumes when we get to the end of next fiscal year, the fund will have a NAV of somewhere around $325 million, which as you can tell from that number assumes a limited amount of third-party fundraising, as Adam just outlined. That assumption in the $0.15 of earnings then assumes that we have about $1.9 million of incremental infrastructure cost, including third-party providers that we have put RMR's $100 million commitment to work throughout the year and we'll start receiving dividends on that. The fund is committed to about a 4.5% dividend rate. So we're assuming cash flows and dividend income from the fund. And then as an equity method investor, we would obviously get our proportionate share of their earnings. So those are some of the key assumptions, I don't know if that's helpful.

Yes, I think that's very helpful. And just one more from me. I heard some banks saw an intense competition from nonbank lenders in the CRE lending space. I just want to get your sense, Adam and Matt, about the opportunities in this space when you look across maybe the opportunity last quarter or going forward?

Sure. Of all the markets we're in and that we operate in, I would say, it is pretty interesting what's going on in the CRE, commercial real estate lending market. It is -- we knew -- it's always been a very competitive market. And I think it has become even more competitive. Some of that's driven by the fact that a lot of money, private funds, especially have been raised, specifically focused on lending in the commercial real estate sector, especially over the last couple of years and that's coupled with the fact that commercial real estate transaction volume year-over-year has been declining modestly over the last couple of years. Again a lot more capital has been raised for this space. And typically these types of financing not always, but a large amount of the financings happen in and around transactions. And you've seen a slowdown in transaction volume at the same time. So it's a typical supply-demand imbalance where you got a lot of capital raised, earmarked for specific sector, and there is less transaction volume to put the capital to work. So I would tell you, yes, your assumption that there has been increased competition is 100% correct in our view. There has -- there is very high competition and you're seeing that in the length of time it has been taking us to make loans in our Tremont business. We've announced so far publicly 4 loans, and it's taken us much longer than we originally had hoped to get that money out. That is largely as a result of the fact that there is a lot more competition in the marketplace for those loans. So I agree with your assumption, there is a lot of competition in the marketplace.

So do you see like going forward maybe looking over the next maybe 2 or 3 years, do you see that it's the trend that business like Tremont can take more business from bank in the CRE lending space?

I think they are not taking so much business from banks because they -- the type of lending that you typically see Tremont do and many of the private capital do has been focused more on what is called transitional bridge lending. That lending -- that type of lending the banks have typically shied away from over the last several years, I don't see them going back into that market. What is really a result of all this is, I just think everyone's returns expectations on lending have come down. The good news in the commercial real estate lending space -- on the commercial side, this is different than residential, but on the commercial side, what I've seen is that lending standards haven't been loosened materially. That's a good thing. That's very different than what we saw in the '06, and '07, '08 time frame during last financial crisis. We saw a lot of loosening of credit standards. But I – so what I've seen among ourselves and our competitors is, people are pretty much sticking to their guns on the credit metrics and the underwriting standards, but pricing has come in. And so that's where you're seeing the competition. And so what's really as a result of all this, I think, a lot of people when they got into this space over the last couple of years were expecting a certain level of return, I think that level of return needs to be tempered just because of the level of competition. So I think that's really what's going on.

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

Thank you for joining us. We also look forward to updating you on our progress during our fourth quarter conference call. Operator, that concludes our call. Thank you.

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