Centerspace (CSR) Q1 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the IRET First Quarter Fiscal Year 2018 Earnings Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Matthew Volpano. Please go ahead.

Thank you, and good morning. IRET's Form 10-Q was filed with the Securities and Exchange Commission yesterday after the close. Additionally, our earnings release and supplemental disclosure package have been posted on our website at www.iretapartments.com and filed yesterday on Form 8-K. Before we begin our remarks this morning, I want to remind you that during the call, we will be making forward-looking statements about future events based on current expectations and assumptions. These statements are subject to risks and uncertainties due to factors discussed in yesterday's Form 10-Q, during this conference call, and in the Risk Factors section of our annual report and other filings with the SEC. Actual results may differ materially, and we do not undertake any duty to update any forward-looking statements. Please note that our conference call today will contain references to financial measures such as funds from operations, or FFO; and net operating income, or NOI, that are non-GAAP measures. Reconciliations of non-GAAP financial measures are contained in yesterday's press release, and definitions of such non-GAAP financial measures can be found in our most recent supplemental operating and financial data, both of which are available in the Investors section of our website at www.iretapartments.com. With me today are Mark Decker Jr., President and Chief Executive Officer; and John Kirchmann, Executive Vice President and Chief Financial Officer. Andrew Martin, Executive Vice President of Operations; and Anne Olson, Executive Vice President and General Counsel, are also joining us and will be available to answer questions. I will now turn the call over to Mark.

Thank you, Matt, and good morning, everyone. This quarter marked a pivotal inflection point for our company. I'm excited and inspired by our team's execution over the last few years and more notably, this quarter, amid significant organizational changes. On May 1, the beginning of our fiscal year, we installed a new senior team and reassigned and realigned many roles and responsibilities. And through my daily interactions and observations, I can tell you that I see a team embracing the changes, taking care of our customers and one another, a team expanding its communication, increasing its trust and reliance on one another, united in purpose and focused on results that benefit our customers and shareholders. Turning briefly to our portfolio. We continue to make progress as shown by the increase in multifamily same-store revenue and occupancy, both year-over-year and sequentially. North Dakota's economy appears to be stabilizing. And with the addition of 873 new units to our same-store portfolio, North Dakota now comprises less of our same-store multifamily NOI, 25% today versus 33% 1 year ago. While Minnesota, one of our key target markets, has grown to 38% from 28% 1 year ago. This is a positive shift, and it demonstrates that our transition is gaining traction. We are still principally focused on providing great service and optimizing revenues, which will result in higher occupancies and rental rate growth. However, as I like to say, there are more coins in the couch cushions, and we are going after them. With disciplined asset management, we will further refine our revenue management tools to better manage unit pricing and align lease expirations with market seasonality. We will evaluate and implement programs like renter's insurance, LED lighting conversions, the expansion of RUBS and others that boost revenue and/or reduce expenses. We strongly believe these points will add up as we execute on the operating side. These items, combined with more efficient assets and property operations, should help us improve our margin, and a little bit of margin improvement is a big deal. Notwithstanding these comments, in fiscal year 2018, we remain focused on 2 primary goals: improving our portfolio operations with a primary focus on occupancy and adding multifamily assets that improve our overall portfolio composition and increase our multifamily share of NOI while reducing our commercial exposure. So with that, let's turn to the first quarter, where I'm very excited to report we met our budget objectives and are tracking to our operating goals for the year. We increased same-store revenue and occupancy in our multifamily portfolio, both sequentially and year-over-year, and, for the first time in our history, pushed above $1,000 of average revenue per unit at our same-store properties. We continued our portfolio transformation by selling $30 million of noncore properties during and after the quarter, and as we mentioned on our last call, we added the 191-unit Oxbo community in St. Paul, Minnesota. This is a brand-new urban asset in an A location. We purchased this newly developed property just after delivery when it was 33% occupied and 44% leased. 3 months in, the property is 52% occupied and 54% leased, and it has tracked to our pro forma estimates that we are beginning to see the natural fall slowdown affecting leasing velocity. In addition, the ground floor retail, over 11,000 square feet, is now fully occupied with 2 fantastic restaurant concepts serving St. Paul's entertainment corridor and adding amenities for our residents. Also, we signed an agreement to acquire Park Place Apartments, a 500-unit community located in Plymouth, Minnesota. Plymouth is a highly desirable western suburb of the Twin Cities. Park Place offers a lot to its residents with close proximity to large employers, highly rated schools and multiple retail, cultural and recreational amenities. The property goes to average units above 1,100 square feet and average rents above $1,300 per unit, providing residents an affordable option in a submarket with incomes and home prices well above metro averages. We completed our due diligence investigation of Park Place and expect to close later this month. In addition to Park Place, in July, we originated a $16.2 million loan on a 182-unit multifamily development located within the western suburb of New Hope, Minnesota, less than 10 miles from the CBD. At quarter end, we had funded a total of $3 million and expect to fund the remainder through January 2018. We recognize that new developments today offer returns in excess of stabilized acquisitions of similar quality assets, though they also bring added risk and capital outlays that don't generate immediate returns. This loan is structured to provide IRET with a current return of the 6% and an option to acquire the property after stabilization. We believe this structure aligns our interest with the developer, eliminates a substantial portion of development risk, preserves balance sheet flexibility and provides us better control and visibility on the cost and timing of a portion of our investment pipeline. Finally, and most importantly, early in the quarter, we completed a 6-month strategic exercise to create a plan that serves as a reliable road map to guide IRET through its transformation and beyond to hold our team accountable for results. With a combination of research data, thoughtful discussion -- and thoughtful discussion, we concluded that deepening our presence in the Twin Cities metro and growing into the Denver and Chicago markets provided the best prospects for rational and disciplined growth. Each of these markets are top 25 MSAs with diverse economies, deep and liquid investment markets, timely and reliable data and submarkets that contain strong favorable dynamics for long-term apartment ownership. We are confident that we can build a great business in these markets and be a valuable market participant. It's also notable that these markets have a relative lack of coverage by other multifamily REITs. So with thoughtful execution, we'll have an outstanding business for our existing shareholders and appeal to a broader audience. Given all of this activity, I hope you'll see why I'm excited for the future and inspired by our team. I would like to say a special thank you to our property professionals who are the face of IRET to our many residents and ensure that our communities reflect our high standards of quality and service. Another thank you to our corporate team members who have worked diligently together these past several months. For our veterans, it's been a matter of endurance; and for our new folks, it's been a sprint. And finally, thank you to our loyal shareholders for listening to our vision, understanding our strategy and trusting us to build IRET for the future while acknowledging our proud heritage as we celebrate 47 years in business and 20 years as a listed company. We progressed a lot this quarter. Together, we are driving a business that better serves our residents and employees as well as our existing and prospective shareholders. We are optimistic about IRET's future and the team we've assembled to execute on our strategy. Thank you. I'll now turn the call over the John Kirchmann.

Thank you, Mark. In my comments today, I would like to review a number of changes we have made to our accounting, reporting and operations, followed by a review of our first quarter results and our balance sheet. Beginning with the changes and additions implemented this quarter. As we announced on our last earnings call, we have increased our threshold for capitalizing expenditures from $250 to $500 as of May 1, 2017, with the goal to increase the quality and consistency of our NOI. As a result, we estimate an increase to expenses by approximately $600,000 to $700,000 for this quarter and subsequent quarters. In addition to our capitalization policies, we reviewed and changed the estimated useful lives of our fixed assets. These changes generally shorten the useful life of our assets and brings us into alignment with our multifamily peers. The impact of this change is estimated in the first quarter to be $14.4 million, of which $9 million represents a onetime charge. We have also suspended our revenue-generating activity while we complete a comprehensive review of our program with the intention of improving its effectiveness, efficiency and increase the rates of return for these capital investments. Our revenue-generating capital program remains a key part of our core operating strategy, and we will restart the program once our review is completed. Finally, we have introduced core funds from operation, or core FFO, which adjusts FFO for items that are nonroutine or not considered core to our business operations with such items identified in the reconciliation of core FFO presented in the supplement to our earnings release. We believe core FFO will provide investors with additional color when comparing our operating and financial performance across periods. Moving to our financial results. Yesterday, we reported total revenue of $52.7 million for the quarter ending July 31, 2017, an increase of 6.3% from the fiscal first quarter of 2017. Core FFO was $13.7 million, or $0.10 per share for the quarter, compared to $0.11 per share for the same period last year. FFO was $0.10 per share this quarter compared to $0.12 per share for the same period last year. Moving to our multifamily same-store performance. Our first quarter results demonstrated strong revenue growth with a 3.9% year-over-year increase from last year's fiscal first quarter and a 2.3% sequential increase from last year's fiscal fourth quarter. The increase in revenue was driven by an increase in average rental rates, which were up 2.7% year-over-year and 1% sequentially, and occupancy, which was up 1.2% year-over-year and 1.3% sequentially. In particular, we continue to see strong revenue growth within our core market of Minneapolis and the surrounding communities of Rochester and St. Cloud with year-over-year revenue growth at 6.9% and sequential growth at 3.2%. Offsetting our growth in revenue was a 13.9% year-over-year increase in same-store expenses. The primary drivers of this increase were the aforementioned change in capitalization policies, an increase in real estate taxes related to the stabilization of development properties and a change to the levy rates in North Dakota, higher turnover cost primarily related to a reduction in revenue-generating capital and increased labor costs. With regards to our balance sheet at April 30, 2017, we have total debt of approximately $839 million. During the quarter, outstanding debt increased by $45 million related to the acquisition of Oxbo. At quarter end, we had $24 million of cash and cash equivalents and $94 million of availability on our line of credit. With that, I'll turn the call over to the operator for questions.

[Operator Instructions] The first question comes from Jim Lykins with D. A. Davidson.

For the dispositions, can you give us an update on what you're thinking there right now for any planned property sales and any color on the time line as well?

Sure. We have -- we are currently analyzing all the commercial properties for disposition with the hope that, that analysis and some sales will be complete by the end of fiscal year 2018. We currently do, as disclosed, have 3 properties under contract. The last 2 of our health care properties will be sold this quarter, if everything goes as planned.

Last of our senior.

Yes, senior housing, health care assets. And then we also have 2 of our smaller multifamily assets that we'll be closing, we believe, this quarter. And we have a couple properties -- a few of our industrial properties that are being widely marketed at this time that we're considering offers on. And otherwise, everything else is being analyzed to make sure that we would have good timing and also be able to redeploy the proceeds of any sales.

Okay. And also for the $60 million loan origination, is this kind of a one-off deal, or is this a change in strategy? Are we going to see more of these from you guys going forward?

I wouldn't say that this marks any kind of the large change in strategy. In our mind, it's consistent with what we're doing, which is trying to identify good risk-adjusted ways to add quality product to the portfolio. So we did -- we're not conducting it, the development on balance sheet. We have a partner, and we feel like we have a structure that aligns us well to cover the downside and capture some upside.

And can you tell us any more of how that's structured once it's completed? You guys mentioned having the option to purchase that property. Will you get that -- will you be able to get that at a discount to current market prices there?

Yes. I mean, I'll give you the high-level version, which is, we have an option to purchase that asset at a 6 cap on a defined NOI within 18 -- starting 18 months after C of O. So in essence, if the developer hits his rent numbers, the asset of a 6 cap will be more worth more than the price we're paying for it, in which case, we'll split that with him. And if it doesn't, if the rents aren't in line with that, we buy it at the 6 cap, and in essence, the developer gets a development fee and their participation. They are also a participating lender in that mezz. So fixed cap, fixed price on a very well-defined NOI.

The next question comes from Drew Babin with Robert W. Baird.

Quick question digging in on the expense growth. If you assume that $600,000 from the accounting change is backed out of the same-property expense growth, we should see same-property expenses still grew to pretty elevated rate during the quarter. So just trying to decompose kind of what items increased the most. Was it mostly real estate tax driven? And if so, was there anything to do on the appeal side to maybe knock that down as the year goes on?

Drew, this is John Kirchmann here. So on the real estate tax side, a lot of that expense was driven by properties that came in to same-store portfolio, new properties through acquisition or redevelopment. And their real estate tax bills hit since -- sorry, the increase to what the market or run rate is hit after the first quarter of the prior year.

Okay. So timing, where it was -- within the same-store pool, if you add results last year, they're being reflected in year-over-year comp. You're saying that the full property tax expense is now be recorded where it wasn't before?

That's right.

Okay, makes sense.

So what I'm saying is the run rate, this last quarter, is -- are -- the amount this last quarter is the run rate.

Okay, that's helpful. And then on the Plymouth deal, I was wondering if you could talk a little about your expectations there, kind of initial. And I know with value add, seeing an opportunity there, what a stabilized deal may look like?

Sure. Yes, we're excited about that. I mean, on our numbers, that's a 5 to 5.25 on in-place and as I think was noted in your note or someone else's, around 184 a door. We have, in our underwriting and budget, roughly $15,000 a door of capital we put into that. It's a great submarket. There is some similar product, all of which has actually been either fully or mostly upgraded recently, and they're getting pretty good lift on their rents. We -- in this project, there are -- a handful that have been done -- a handful of renovations and upgrades. And the rent increases were substantial. So we're pretty optimistic about that.

The next question comes from Rob Stevenson with Janney.

This is Venkat in for Rob. Just a quick one from me. John, with the introduction of the core FFO disclosure this quarter, should we not expect an AFFO calculation going forward? And just curious, like how should we think about recurring CapEx going forward in some of those line items?

Sure. So our recurring -- most of our capital cost that isn't revenue generating or related in acquisition, we consider to be recurring. So the way, I guess, I would look at that would be the capital that we are spending that we aren't disclosing as revenue-generating or acquisition related would be recurring. I don't know if that helps you or not. Is that what you're looking for?

Yes, and just trying to think of how we should think about it going forward without some of the disclosures.

This concludes our question-and-answer session. I would like to turn the call back over to IRET's CEO, Mark Decker, for closing remarks.

Thanks, Anita. We're excited about IRET's future, and we appreciate everyone's interest. Have a great day, everybody. Thank you.

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