Creative Media & Community Trust Corporation (CMCT) Q1 2023 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Creative Media & Community Trust First Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Steve Altebrando. Please go ahead.

Good morning, everyone, and thank you for joining us. My name is Steve Altebrando, Portfolio Oversight for CMCT. Also on the call today is Shaul Kuba, our Chief Investment Officer; David Thompson, our Chief Executive Officer; and Barry Berlin, our Chief Financial Officer. This call is being webcast and will be temporarily archived on the Investor Relations section of our website, where you can also find our earnings release. Our earnings release includes a reconciliation of non-GAAP financial measures discussed during today's call. During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of, assumptions made by and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties, and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations and those differences may be material. For a more detailed description of potential risks, please refer to our SEC filings, which can be found in the Investor Relations section of our website. With that, I'll turn the call over to David Thompson.

Thanks, Steve, and thank you everyone for joining our call today. We made tremendous strides in the quarter, executing on our previously announced plan to grow the multifamily side of our portfolio to achieve more balance between creative office and multifamily. During the first quarter, we completed the acquisition of two multifamily assets in Oakland and one multifamily property in Los Angeles. These newer vintage, highly-amenitized, premier multifamily assets in high barrier-to-entry markets added 696 units to our growing portfolio. We also started construction on the luxury multifamily portion at 4750 Wilshire in Los Angeles after closing a co-investment and a construction loan in March. This will add another 68 residential units to the portfolio. We believe this is an attractive project given the assets location in Hancock Park, a supply constrained neighborhood that is adjacent to multimillion-dollar single family home. In addition, we have a large pipeline of multifamily development opportunities on land we already own. As we previously mentioned, for value add and development assets, we will look to co-invest to increase our diversification and supplement returns by generating fee income where advantageous, just like we did with 4750 Wilshire. During the quarter, we also took steps to improve our liquidity and balance sheet. We completed a securitization of our loan portfolio that generated net proceeds of approximately $43.3 million. We also generated $23.6 million of proceeds from our Aeries A1 in preferred stock offering in the quarter. These steps to improve liquidity follow the refinancing of our credit facility in the fourth quarter. We believe the refinancing of our secured facility, which is largely backed by several of our high quality office assets, demonstrates the strength of our portfolio. Turning to the first quarter, we continued to see a strong rebound at our hotel asset with NOI increasing 73% from the prior-year period. Our office NOI declined year-over-year and declined 1% from the fourth quarter. We have over 50,000 square feet of leases signed, but have not yet commenced. Our multifamily segment generated $675,000 of NOI in the quarter. While our lending business NOI declined year-over-year, we were able to generate significant proceeds from the segment through the securitization of the loan portfolio. CMCT reported core FFO of negative $0.06 per share compared to positive $0.10 in the year-earlier period. This was primarily driven by higher interest expense due to our Channel House acquisition, which is still in the process of being leased up. I would now like to turn the call over to Shaul Kuba.

Thank you, David. I'd like to take the time to provide more color on our recent multifamily portfolio expansion and give you an update on the status of our development pipeline, which is also primarily multifamily. As David described, we have focused our acquisition target on new vintage, highly-amenitized, premier asset in high barrier-to-entry market. We were pleased to add three properties that fit that criteria. First, in Echo Park, in Los Angeles, we completed the acquisition of 50% interest in 1902 Park Avenue, a 75-unit apartment building, in an off-market transaction. Our basis in 1902 Park Avenue is highly attractive at approximately $300,000 per door, which we believe is substantially below replacement cost for a building that was constructed in 2012. We are in the process of making some cosmetic changes, including upgrading the landscaping, lighting and common amenities to the building, which require limited CapEx. We believe this will have an outsized impact on the desirability of the building for residents and provide significant opportunity to increase rent to market rate over time as new tenant move in. Next, in Oakland, as David mentioned, we completed the acquisition of the Channel House, a 333-units 8-story apartment building, and 1150 Clay, a 288-units 16-story apartment building. Both assets are premier Class A building that were completed in 2021. We believe the current market challenges in the Bay Area and Oakland present us an opportunity to acquire those assets at a highly attractive basis that is substantial discount to current replacement cost. Our basis for Channel House is approximately $415,000 per door and 1150 Clay, it is $535,000 per door. Oakland is a market that saw significant supply growth from 2008 through 2022. This is new supply, is in the process of being absorbed, which we expect to take a little time. However, the pipeline for new development is significantly below the average for the top 25 U.S. market, and the rent would need to increase dramatically before it is economic to build. In addition, the cost of renting significantly lower than owning in this market. Those assets were acquired with attractive mortgage that were in place during the development of those assets. Once those assets are stabilized, we would like to look to refinance into longer-term financing. Turning to our development pipeline. As we have previously discussed on those calls, we conducted an extensive review of our portfolio last year. As a result, we believe we can develop more than 1,500 multifamily units on land we already own in Austin, Los Angeles, the Bay Area and Sacramento. We continue to make progress on those pipeline. In Los Angeles, we have two ground-up development projects that are now fully entitled, and we are now in the process of obtaining building permit. The first one is a 36-unit multifamily development in Echo Park, adjacent to two other CMCT assets. The second is a 40-unit multifamily project in Jefferson Park. These assets is located in the path of growth, in close proximity to Culver City and just a mile-and-a-half from the University of Southern California. We will have the option to start construction this year on this two ground-up opportunity. For the balance of our pipeline, we continue to work to obtain all the necessary approval as well as completing design work, which we believe will increase the value of those holding and allow for future growth. I also wanted to provide an update on 1910 Sunset Boulevard in Echo Park, the office asset we acquired with a JV partner in 2022. Since acquiring the asset, we have been actively upgrading the building to meet the demand of entertainment, media and technology company. We are pleased that the leased percentage has now increased to 90%, up 10% from the end of last year. With that, I will turn it over to Steve to provide an update on the portfolio.

Thanks, Shaul. I will provide a quick update on our leasing activity. Starting with the multifamily portfolio. On a consolidated basis, our multifamily was 80.7% occupied at the end of the quarter, as our two largest assets are still in the process of initial lease up. Occupancy at Channel House increased to 80% at the end of the quarter, up 4 percentage points compared to the end of 2022. And occupancy at 1150 Clay also increased to 80% at the end of the quarter, up 3 percentage points from the end of 2022. In addition, we continue to see occupancy increase into April. At 1902 Park in Los Angeles, our in-place rents are substantially below market, and we have been executing leases for new tenants over 20% higher than are in-place rents. Turning to office, we leased approximately 44,000 square feet in the first quarter. Our occupancy rate at the end of the first quarter was 81.3%, while our lease percentage was 84.4%. We have approximately 51,000 square feet of leases that have been signed, but not yet commenced. As I noted on the last call, we entered 2022 with nearly 15% of our leases expiring during the course of the year. This year, it is a much more manageable 11%. In total, we continue to estimate that we will renew more than 70% of these leases. We only have one tenant expiration over the size of 10,000 square feet in 2023. With that, I'll turn it to Barry.

Thank you, Steve. Moving on to financial highlights. Our segment net operating income increased to $13 million compared to $12.2 million in the prior-year comparable period. By business segment, this change is broken out as a $1.8 million increase in our hotel segment NOI, as well as $675,000 of NOI from our newly acquired multifamily segment, partially offset by a decrease in our office segment NOI of $1.2 million and around a $400,000 decrease in our lending segment NOI. More specifically, first, our office segment NOI decreased to $6.8 million from $8 million in the prior-year comparable period, driven mainly by a decrease in the NOI for our same store properties. This was caused by a decrease in occupancy in an office property in Los Angeles as well as one in San Francisco. In addition, there was an increase in non-reimbursable operating expenses at a property in Beverly Hills, California. Our office segment continued to see improved activity and we signed approximately 44,000 feet of leases during the quarter. Please also note that we are not yet seeing the benefit of our lease to the Rolls Royce dealership at our Beverly Hills property. Second, our hotel segment NOI continued its positive period-over-period trend and increased to $4.1 million from $2.4 million in the prior-year comparable period. This was driven by both improved occupancy, which increased to 81% from 69%, and improved ADR, which increased to $202 per room from $173 per room Third, we began reporting multifamily segment NOI in the first quarter of 2023 after we acquired two multifamily properties in Oakland in February and March, and invested in another multifamily property in Los Angeles through a 50% joint venture investment. Our multifamily segment NOI was $675,000 for the first quarter of 2023. As of March 31, 2023, our multifamily properties were 80.7% occupied with monthly rent per occupied unit of $2,852. Finally, our lending division NOI decreased to $1.4 million from $1.7 million in the prior-year comparable period. The decrease was due to an increase in allocated salary expenses related to the issuance of new SBA 7(a) loan-backed notes in connection with the securitization that closed in March 2023, and an increase in interest expense relating to that debt, as well as lower revenues relating to lower premium income as a result of lower loan sale volume. For our non-segment expenses, we had three main impacts: transfer taxes on our acquired multifamily assets, front-loaded amortization of in-place leases, and interest expense. The largest increase was $4.5 million increase in depreciation and amortization expense, driven by an increase in acquired in-place lease and tangible assets' amortization at our new multifamily properties located in Oakland, which will continue to be absorbed for the next few quarters. We also had an increase in transaction related costs of $3.4 million relating to the transfer tax expenses incurred in connection with the acquisition of our multifamily properties in Oakland. And non-segment allocated interest expense increased by $3.9 million, primarily due to an increase in the interest rate and average outstanding balance on our credit facility compared to the prior-year comparable period, as well as additional interest expense related to the assumption of two mortgages in connection with the acquisition of our two multifamily properties in Oakland during the quarter. These increases in non-segment expenses were partially offset by a gain of $1.1 million recognized in connection with the sale 80% of our interest in our property at 4750 Wilshire in Los Angeles. Our FFO was negative $0.21 per diluted share compared to a positive $0.09 in the prior-year comparable period, which was a result of below-the-line transfer taxes and by increased interest expense. And our core FFO was negative $0.06 per diluted share compared to a positive $0.10 per share in the prior-year period, primarily driven by the increased interest expense. Finally, our liquidity was bolstered by completion of the securitization and through raising an additional $23.6 million in net proceeds from the sale of our Series A1 preferred stock during the quarter. We also had incremental borrowings on our revolving credit facility of $122 million, mainly due to the asset acquisitions, with $28 million of remaining borrowing capacity as of March 31, 2023. Our credit facility currently has $45 million of borrowing capacity. With that, our host can now turn the call over for questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Eric Speron with First Foundation. Please go ahead.

Hey, guys. Thanks for taking the question. And again, I'd love the [attendance] (ph) on the call. We really appreciate it. My question is on the Sheraton Grand. A couple of years ago, I don't know if you guys said it or it was just whispered by brokers, you guys -- there was a book out there. You guys have done exactly the right thing, waiting for occupancy to move. I mean, those were really impressive numbers in the quarter. ADR -- obviously the leisure recovery is here. So, I kind of take the perspective of an owner of the business of CMCT and I look at it and say, these guys, it was reported that they were considered selling. They kind of did the right thing last time and not. But why -- so my question is two-fold. One, why isn't this the right time to monetize that asset? And then two, as you look at largely unfunded buyback, the hard work you've done on the debt side and an offer in the market to buy the company, isn't it in both the case that it might be the right time to harvest and it might also be the right time to seed? So, I kind of just wanted you to address kind of the hard work you've done to get Sheraton Grand here? And how you see the seed-harvest cycle kind of on both sides?

Sure. Hey, Eric, I could take this. It's Steve.

Okay.

So, I mean you are correct. We did market the property late 2021 and we decided based on the values of that time that we were better off holding and waiting for the recovery to take place. And as you can see by the numbers, clearly the results have picked up pretty dramatically at the hotel. And as we look forward for the balance of 2023 just in terms of group bookings, we're seeing the trends continue to be very strong both in terms of the amount of nights booked, plus the rate that we're seeing are all up meaningfully from 2022. And right now, we're at the point where we are starting to evaluate next steps for the hotel and I think it really comes down to at some point the hotel does need a refresh. So internally, the evaluation that we're doing is, does it make sense for us to do the refresh and then potentially look to market it, or vice versa. But that's effectively the work that we're doing right now.

Yeah, that makes total sense in the harvest. Can you talk about seed, right? I mean clearly your portfolio composition is being remade kind of before our eyes in terms of office to multifamily, the asset lighting. But then we're also -- you also -- I don't know, you did a good job on the debt side. So it seems like there's also an opportunity whether or not something happens with the offer to buy the company from a third party or at least to fund the buyback. Can you talk about how you see the opportunity to seed? Because you're clearly doing it in your core business, but also there's the opportunity to do it in the business that we already own. So, do you want to just address the seed?

Yes, what are you referring to the seed?

Well, if you harvest out of the hotel, clearly you're going to be planting seeds. And it seems like both things have gotten better. I respect your answer on the hotel. I think the right answer. It's the one I would expect of you. And I just kind of wonder how you see, if it was monetizable, what are the calls on capital as you look at your stock, as you look at the repositioning, I mean, your ownership that has grown. So I kind of wanted to hear if we were to get a revaluation and feel -- the green light said "Go, sell the hotel," I mean, if you have capital of that size, what would be use of proceeds?

Yes. I think we would have to -- we would re-evaluate it at the time if we're closer to recognizing proceeds frankly. So right now, I mean, a big focus internally is really growing the multifamily portfolio. And then, with the acquisitions that we just completed, really growing the cash flow, both on the revenue and cost side. And then, in addition to that, as you know, we still have some amount outstanding on the buyback that we announced last year as well, which we will continue to evaluate. And really it's a balance between repurchasing shares and some of the internal investment that we have and some of which might not require a lot of capital, because we [indiscernible] on the development side looking to partner with others on these deals. So that's the way we're thinking about capital allocation at the moment.

Okay. Yes, I mean, I just -- you got an opportunity to do -- if that's the size of the check to me, it seems like there's an opportunity to do both. So, keep us posted.

The next question is from Gaurav Mehta with EF Hutton. Please go ahead.

Yes, thanks. I wanted to ask you on your multifamily portfolio. The 80% occupancy, and I think you mentioned that occupancy improved in April. When do you expect these assets to stabilize?

So, I think from an occupancy standpoint, we would expect a stabilized level within the next 12 months. But we still think there would be an opportunity to continue to grow rate thereafter. So, I wouldn't consider that to be totally stabilized. And what we're seeing in the Oakland market was there's a large amount of supply that hit it once and now we're really at the tail end of that, which was why we thought it was attractive to now be entering that market as a supply is being absorbed and going forward, but just we don't expect it will be meaningful new supply for quite some time. So, we think we're in at the right point of the cycle. But we do think it will take -- particularly on the rate side, it will take a little bit of time to -- for us be able to meaningfully push rate that was the way we underwrote these acquisitions. But ultimately, we think there's going to be a lot of rate opportunity down the line. So I think to kind of summarize, I think from an occupancy perspective, we believe we should be at stabilized level within a year, but we think there's still going to be a lot of growth coming out of those assets from rate going forward beyond that.

Okay. Second question on the office lease expiration. I think you mentioned 11% leases expiring in 2023. What's the timing of those lease expirations in 2023, in which quarters will those leases expire?

Yes, they're pretty evenly spread. None of them are of any material real size. We also mentioned that there was only one lease over 10,000 square feet. So, they're smaller leases that are pretty ratably maturing over this next year.

Okay. Thank you.

This concludes the question-and-answer session, and the conference has also now concluded. Thank you for attending today's presentation. You may now disconnect.