Centerspace (CSR) Q4 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the Investors Real Estate Trust Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Jonathan Bishop, Vice President of Finance. Please go ahead.

Thank you, and good morning. IRET's Form 10-K for the full year 2019 was filed with the SEC yesterday after the market closed. Additionally, our earnings release and supplemental disclosure package have been posted on our website at iretapartments.com and filed yesterday on Form 8-K. Before we begin our remarks this morning, I need to remind you that during the call, we will discuss our business outlook and will be making certain forward-looking statements about future events based on current expectations and assumptions. These statements are subject to risks and uncertainties discussed in our release and Form 10-K and in other recent filings with the SEC. With respect to non-GAAP measures we use on this call, including pro forma measures, please refer to our earnings supplement for a reconciliation to GAAP, the reasons management uses these non-GAAP measures and the assumptions used with respect to any pro forma measures and their inherent limitations. Any forward-looking statements made on today's call represent management's current opinions, and the company assumes no obligation to update or supplement these statements that become untrue due to subsequent events. With me this morning is Mark Decker, our Chief Executive Officer; as well as Anne Olson, our Chief Operating Officer; and John Kirchmann, our Chief Financial Officer. At this time, I'd like to turn the call over to Mark.

Thanks, John, and good morning, everybody. We appreciate you joining to discuss our full year and fourth quarter 2019 results. 2019 was an incredible year for the business, our shareholders and our team. And I'm very proud to be part of what we've accomplished. To the IRET team, thank you so much for a job well done. The big highlights of 2019 include core FFO growth of 9%, balanced NOI growth produced by strong markets and disciplined operations, and finally, a dividend coverage ratio that has improved from minimum coverage in 2018 to a healthy margin of safety in 2019. I'd like to take a moment now to bridge our 2020 outlook. Heading into this call, consensus estimates were $4 of core FFO per share. With a midpoint in our range of $3.66, we need to highlight the key components of the difference. First, the sale of the Sioux Falls portfolio in December of 2019 had an $0.18 to $0.20 impact on 2020 FFO. As a reminder, this was a qualitative win, and we were excited to exit a low growth, low margin market at a premium to our NAV. That adjustment hasn't made it into consensus yet. The second factor impacting our 2020 outlook is our noncontrollable expenses. Overall, we expect our total real estate taxes to increase 14% in 2020 versus '19. A major component, close to 50% of this was in Rochester, where our taxes went up 28% portfolio-wide. Rochester is investing in their infrastructure to transform what is a global center of excellence in medical research into a more dynamic place to live, which we support. Nevertheless, we'd like to see a more measured approach to funding infrastructure, and we will be appealing our valuations in Rochester as well as in other markets where we saw taxes rise higher than expected, particularly in Minneapolis and Nebraska. Lastly, on the insurance front, our whole industry is experiencing significant increases, both in the cost of insurance as well as reduction in coverage through higher deductibles and stop losses. And the difference in 2019 versus 2020 is in the teens, not the high single digits as we were expecting. Taken together, the increase in real estate taxes, insurance premiums and our deductibles and stop loss in excess of our expectations, reduces our 2020 FFO outlook by $0.17 to $0.19 or $0.35 to $0.39 in total. I should also comment that we sold $203 million of assets in 2019 and have only redeployed $169 million. We also took the opportunity in the fourth quarter to raise equity to fund our early 2020 pipeline. So we started this year with $44 million in cash. These combined proceeds will fund our planned Q1 investments, including development financing we closed in late 2019 for the construction of a great new apartment community in Minneapolis, where we will earn a strong return as a lender and have the option to purchase upon stabilization. While the construction loan will be funded over the course of the year, these investments will get us fully redeployed on a leverage-neutral basis and are all funded today. The 2019 sales were a trade-off of short-term earnings for long-term durable cash flow growth, and we're excited for how these activities have positioned us for the future. The per share impact of exiting Topeka and Sioux Falls and reducing our exposure to North Dakota was managed by the excellent results we achieved with our recent long-term financings. If we've had the opportunity to tell you our story, you've heard us talk about 3 key goals. These are: first, grow core FFO and distributable cash flow with a target of greater than 5%; second, improve our exposure to growing markets; and third, maintain and improve the quality and flexibility of our balance sheet. Given the combination of items I've just outlined, while 2020 may miss the core FFO growth goal, we certainly hit markets and balance sheet hard. And we should grow our distributable cash flow in 2020. While I'm not thrilled about guiding to a year-over-year decline in core FFO as I look at our total portfolio today versus 1 year ago, I'm ecstatic about what we got for these decisions. Quality counts. Here are some great comparisons. In January 2019, we had 87 communities with an average size of 157 units per community. And today, we have 69 communities with an average size of 173 units. Our 2019 dispositions resulted in a reduction of the number of roofs in our portfolio by 303 or 26%. Our total portfolio average rent increased by 10% and NOI margin should increase by 80 basis points. NOI derived from our target markets of Minneapolis and Denver increased from 31% to 41%. Our balance sheet is also much improved. We reduced our aggregate number of mortgages by half, and we sit at 50% unsecured today. We also reduced our average interest rate by over 50 basis points, while increasing our weighted average maturities from 4.6 to 6 years and continue to ladder our maturity schedule. Qualitatively, we had some big milestones since our last year-end call also. Most notably, we accessed the private placement market and achieved pricing comparable to investment grade -- other investment-grade REIT issuers. We also accessed the equity market very efficiently with our ATM, the company's first primary common equity issuance since 2013. And our equity market cap rose from $650 million at 12/31, 2018, to $950 million on 12/31, 2019, as the market recognized our transition from diversified to multifamily and our efforts around comparability and transparency bore fruit. Just a few weeks ago, IRET was included in the S&P SmallCap 600, and we've seen a big lift to over $1.1 billion of equity cap and a float of a -- roughly $1 billion. This opens up a new world of investors and should add to our daily liquidity. Our rise by five initiatives continue to bear fruit, and we expect to continue our progress to achieve this critical goal. Noncontrollable expense growth of 11% plus in 2020 is an impediment, but we have momentum on operational improvements, and we're going to work to control what we can. Our team has proven over the past 3 years that we are agile, innovative and can successfully execute on our plan to build a great company. There's still lots to do that energizes us. Turning briefly to the markets. We continue to like Minneapolis, greater Minnesota and Denver, which now comprise over 60% of our cash flow. We're seeing continued enthusiasm from capital and the development community built upon continued strength in housing fundamentals, underpinned by high incomes, household formation and a great employment market. Our secondary markets all remain healthy with reasonable supply and strong fundamentals. So in summary, we took advantage of the market and achieved great pricing on our tertiary market sales in 2019. We still have lots of work we can do in our own portfolio to continue driving value. We have a pipeline of investments that is funded on a leverage-neutral basis. And when we find further acquisitions that we believe create long-term pricing power and add to the portfolio strength as well as the per share financial results, we have the flexibility to act. And with that, Anne -- and I pass the mic.

Thank you, Mark, and good morning, everyone. I'll keep my remarks on our operations brief. As you heard, we have a lot of work to do to mitigate the impact of taxes and insurance, and I'd better get to it. But first, let's take a minute to talk about our 2019 efforts and what we are focused on for 2020. With 3.6% same-store NOI growth in 2019 compared to 2018, we feel good about our continued progress. Our year-over-year growth is driven by a combination of revenue growth and 70 basis points of occupancy. The fourth quarter saw increasing occupancy throughout the period, and the trend has continued into February, with today's same-store occupancy at 95.3%. Increasing occupancy, coupled with steady occupied rents, led to year-over-year gains in rent per unit of 2.9%. Our renewal percentage held steady in 2019 at 50%. And while the difference in new lease rents across the portfolio was relatively flat, we were able to push our average renewal rents 5.1% for the year. As we sit today, we're in a very similar position to where we were in 2019 from an occupancy and exposure standpoint, but we are achieving higher rents. Overall, our markets performed well in 2019. We're pleased with the revenue growth in our Minnesota markets, particularly Minneapolis, where we saw a 5.6% growth year-over-year. We're also pleased to see the increased efficiencies in our North Dakota markets. Expense containment initiatives there resulted in strong NOI growth across that portfolio. It is notable that in Omaha, we had a year-over-year decline in NOI. This was the result of increased expenses associated with real estate taxes and insurance claims. Weather-related damages incurred in early 2019, resulted in a year-over-year occupancy decline of 1.2% from units that had to be taken off-line for repairs. The portfolio has recovered, and today, our occupancy in this region is 94.5%. We are executing on our plan to rise By 5 with the goal of increasing our NOI margin by 500 basis points. We refined our expectations and process around expense control, but did realize some fourth quarter expenses related to roof repairs that we had anticipated would hit in our CapEx. This inclusion of $230,000 in our expenses negatively affected our year-over-year expense growth by 40 basis points. With respect to our revenue initiatives, you may remember that in May 2019, we removed all of our caps for our utility reimbursements or RUBS. And as this rolled through the portfolio, we realized income of $885,000 in the fourth quarter of 2019, which was a 25.2% increase compared to the same period in 2018. Similarly, our renters' insurance program, which also kicked off in May 2019, brought in $110,000 in the fourth quarter. Both our RUBS and renters' insurance will continue to positively impact our results as we move through these final few months of the rollout. Our same-store NOI margin was flat year-over-year, but we have made progress on the components of our business that we can control. Our efforts resulted in an increase to gross margin of 50 basis points in 2019 compared to 2018. Since starting our rise by 5 in 2018, our overall NOI margin has increased across our portfolio by 200 basis points. A key component of our rise by 5 is our value-add renovations. We completed 44 unit renovations in the fourth quarter as our leases roed, bringing our 2019 total to 166 units across 3 assets. And as of today, we have two new clubhouses under construction in our Minneapolis market as we work to reposition assets with both amenity and unit renovations. In the fourth quarter, our average cost of in-unit renovation was $10,667 and our achieved premium averaged $154. In 2019, we invested approximately $5 million into our existing portfolio. We're also executing on our plan for unit and amenity renovations in Omaha and Lincoln, and we anticipate spending $10 million to $15 million in value-add capital in 2020, while staying flexible and committed to getting our underwritten returns. Our 2020 rise by five focus is on a resident experience. We're in the final stages of our lead-to-lease platform rollout and are at the beginning of rolling out enhanced training and onboarding on our interactive training platform that was implemented in 2019. We are additionally exploring how we can improve our position going into our next insurance renewal and what our best practices are in real estate tax advocacy and appeals. By focusing on providing an excellent customer experience and achieving consistency throughout our portfolio to enhance scalability, we will execute on the goals of cash flow growth, enhanced market exposure and balance sheet flexibility. We have a team that is experienced, committed and fully aligned with our mission, which is to provide a great home for our residents, our team and our investors. John can't wait for these efforts to hit the bottom line, so I'll let them tell you how our company-wide efforts impacted our 2019 results and 2020 outlook. John?

Thank you, Anne. Last night, we reported core FFO for the 12-month period ending December 31, 2019, of $3.72 per diluted share, an increase of $0.31 or 9.1% from the prior year. For the quarter ended December 31, 2019, core FFO was $0.96 per diluted share, an increase of $0.04 or 4.3% from the prior year. The increase in full year core FFO is primarily due to NOI growth, reduced interest expense from refinancing of debt at more favorable terms and lower general and administrative expenses, partially offset by higher property management expenses and casualty losses from weather-related events. The rate of core FFO growth in the fourth quarter was reduced by the dispositions that took place during the third and fourth quarters net of the impact of new acquisitions during the third quarter. Looking at our general and administrative expenses, total G&A was $14.5 million for the year, a $400,000 decrease from the prior year period. For the quarter ended December 31, 2019, G&A at $3.6 million was in line with the prior year. Property management expense was $6.2 million for the full year, a 12% increase compared to $5.5 million for the prior year. The increase is primarily due to the implementation of new technology solutions related to improving our resident experience. Moving to capital expenditures as presented in Page S-13 of the supplemental for the quarter ended December 31, 2019, same-store CapEx was $4.4 million, a $1.7 million increase from the prior year. This increase was expected and due to a delay in the timing of the start of some capital projects during the first half of 2019. Full year same-store CapEx was $871 per unit, which is lower than our original guidance for 2019 of $900 to $925 per unit. As discussed earlier by Anne, during the fourth quarter, $230,000 of planned roof repairs were recorded as maintenance and repairs instead of Capex, which contributed to the lower per unit CapEx spend. In addition, value-add spend for the quarter increased to $2 million and was $5 million for the full year as we continue to roll out the value-add programs Anne discussed earlier. Turning to our balance sheet. As of December 31, 2019, we had $227 million in total liquidity, including $199 million available on our corporate revolver. We continue to make great strides in decreasing our secured borrowings, increasing our weighted average term to maturity and lowering our interest costs. At December 31, 2019, we have 24 mortgage loans outstanding with the balance of $331 million versus 50 mortgages outstanding with a balance of $446 million at December 31, 2018. These improvements to the balance sheet increase our flexibility as we seek to improve our portfolio in our target markets. During the year ended December 31, 2019, we disposed off 21 noncore apartment communities, two commercial properties and 3 parcels of land for an aggregate gross sales price of $203 million. Proceeds from these sales were primarily used to acquire three new apartment communities for a total aggregate price of $169 million. As of December 31, 2019, we have $44 million of cash on hand that is available to be redeployed, including $17 million of 1031 Exchange funds from the December sale of the Sioux Falls portfolio. As a result, our net debt-to-EBITDA ratio has improved to 7.2x as of December 31, 2019, from 7.8x as of December 31, 2018. During the 12-month period ended December 31, 2019, we repurchased and retired approximately 465,000 common shares and operating unit for an aggregate cost of $26 million at an average net price per share of $56.24. During the fourth quarter, we registered an ongoing at-the-market offering and sale program for up to $150 million in common shares, for which, we issued 308,000 shares at an average net price of $72.29 per share for a total net consideration of $22 million. Looking ahead to 2020, as presented in our earnings release, our outlook for core FFO is a range of $3.52 to $3.80 per diluted share, with a midpoint of $3.66 per diluted share. As shown on Page S-15 of the supplemental, FFO growth for 2020 is impacted by a reduction of $10.8 million in NOI from 2019 dispositions, offset by an increase of approximately $4.8 million in nonsame-store NOI in 2020 for 2019 acquisitions. In addition, 2020 investments of $66 million to $72 million from the undeployed proceeds held at December 31, 2019, are expected to add approximately $1.5 million of net accretion to 2020 FFO. Finally, 2020's outlook is favorably impacted by approximately $3 million of lower interest cost as a result of 2019 debt refinancings. For our same-store communities, we expect NOI to grow between 1% and 3% in 2020. This reflects expected same-store revenue growth between 2.5% and 4% and same-store property operating expense growth between 4.5% and 6%. We expect revenue growth to come from rent growth and other income initiatives that seek to optimize our overall revenue stream. Impacting same-store expense growth is an increase in noncontrollable expenses due primarily to a $1.9 million or 11% increase in real estate taxes as a result of higher property valuations and a $500,000 or a 13% increase in insurance costs as insurance carriers seek to offset adverse catastrophic loss experience by increasing rates across the country. In addition to higher insurance premiums, we are also seeing a reduction in coverage through increases in our stop loss and changes to our deductibles resulting in an additional $550,000 of expected casualty losses for 2020 for a total projected impact from changes in insurance premiums and coverage of over $1 million. On the controllable side of operating expenses, we are seeing the benefit of our rise by 5 initiatives with generally flat to modestly increasing costs. However, most of our markets continue to experience low unemployment and increasing wage pressure. And we expect 2020 same-store compensation cost to increase 5% to 6% as we respond to market conditions. Total same-store controllable expenses, which include repairs and maintenance, utilities and marketing and administrative costs as well as compensation costs, account for 2/3 of total expenses and are expected to increase 1.5% to 3%. Now turning to general and administrative and property management expenses for 2020. We are projecting our G&A expense to continue the current run rate of $3.6 million to $3.8 million per quarter for 2020. Property management expenses for 2020 are expected to increase $300,000 to $600,000 for costs related to the continued implementation of new technology initiatives. Turning to capital. Same-store capital expenditure costs for 2020 are expected to range from $825 to $900 per unit, while our value-add program capital spend is expected to range from $10 million to $15 million. In closing, I would like to reiterate Mark's comments that while our 2020 outlook may not reflect the qualitative improvements we have made to our portfolio during the year, the construction of the portfolio, durability of our cash flow, flexibility of our balance sheet and improved exposure toward target markets, provide a more valuable company with greater long-term growth potential than we had 12 months ago. I would like to thank each of our team members who embraced the change we are affecting and who choose to dare to win on a daily basis. With that, I will turn the call over to the operator for your questions.

[Operator Instructions]. And our first question today will come from Gaurav Mehta of National Securities.

First question on the dispositions in kind of going forward in 2020. I guess, as you think about further improving your portfolio and recycling capital out of tertiary markets and taking advantage of the pricing that you guys are seeing in the market. How do you balance that with your goal of improving earnings going forward?

Yes. Carefully. I mean, I think it's -- what we saw last year was a lot of gains on the operating side and a big opportunity on the financing side. And so as I think we've commented in the past, we really pulled forward some of those sales. I think one of the things that we've said to the investors, and we just said a few moments ago, is we're really committed to try and deliver a greater than 5% core FFO and AFFO growth. And we didn't do that this year because we got caught a little bit on the taxes. So we're going to have to find ways to do it in a way that stays balanced. So we'll be very picky about it. I do think the market is -- continues to be exceptional to sell anything. So I mean, we've certainly got our eye on the ball there. But I think, absent something that's really exceptional, we're going to be really focused on ops and doing our best to eke out some per share growth this year.

Okay. And second question, can you maybe talk about the timing of redeployment of the proceeds? I know you have $66 million to $72 million of investments in 2020, maybe provide some more color on when you expect to close that.

Yes. So roughly half of that -- or a little less than half of that is this construction loan, which I'll talk about in a moment. The balance is 2 assets that I expect us to close, if everything goes as we have planned in the first quarter. So the loan is a construction loan, our counterparty is Trammell Crow commercial out of Chicago. It's a group we know well. They've built one of our assets here in the twin cities called Arcata, and they're very active in the market. So we had a high degree of confidence in them and their work. The asset will be 130 units over a local grocer Lunds & Byerlys, which is a great local company that has, I think, 27 or 28 stores in the twin cities market. And really, we're right there with Whole Foods, prepared foods and a bunch of things like that, that really get people excited about grocery experience. So it's in a fantastic neighborhood. The -- like Nokomis area, where there's a lot of park amenities. There's a nice couple area -- couple block area with some good restaurants and things, and there's been really no new supply there within a couple of mile radius. So we're really excited that the amenity there is the location. There are some added amenities with the grocer and what's kind of right out your front door. The price point we're really excited about, which I think the average rents there'll be in the $1,700, $1,800 range, which is attainable to many. This is a very desirable neighborhood, South, Minneapolis. The structure of the deal, which is probably what folks care about the most at this point is, it's a two piece -- two loans. One is a first mortgage, roughly $29.9 million. It's 4.5% fixed rate. We funded, I think, $6 million of it at the end of the year. So -- right at the very end of December. And we'll continue to fund the draw. So it's a -- that's a first mortgage -- construction mortgage. And then we have a second, which is a mezzanine loan of about $15 million that's at 11.5%. We won't really get into that till next year. So we might get a little of that funded by the end of 2020, but most of that will be in 2021. And then those two things will run until the asset either gets sold or we buy it. We have an option to purchase it. That would be our plan. So we're really excited about that. I think it's a great opportunity for us to continue to build on our portfolio here in the twin cities.

Our next question will come from Rob Stevenson of Janney.

Can you talk a little bit about what you're seeing in your Minneapolis market operationally? How much new supply is the market seeing? And how much of that's directly competing against your assets? And then also, are you guys making a call of rental rate over occupancy as sub 92% occupancy seems abnormal in the days of revenue management systems?

Yes. A couple of questions there. I'll start with the supply picture and then ask Anne to talk about occupancy. But what we're seeing in the twin cities is depending on whose numbers you read, we're somewhere between 6,000 and 7,500 units, which would be as high as we've been in the supply cycle in this economic cycle. On the other hand, this is still one of the most occupied markets of any major market, and we continue to see rent growth. So I'd say that the overall supply picture for the whole market is balanced. There are a few areas where there is, I would say, some heightened supply. So in particular, in the Downtown market where there's been some new rules around inclusionary zoning, a bunch of developers ran through the window there to try to get deals done before that became the law, which just happened at the beginning of this year. And then there's a few submarkets and some of these affect us. So for example, in the Downtown market, our asset, 132 units Red20, 5- or 6-year old asset now has within a 5- or 6-block radius, 2,000 new apartments, most of which are actually high-rise. So I mean, we've got a really good basis there. The competing product that's in lease-up right now is getting $2.50 to $2.70 a foot in rents, and we're in the $2.20s. So with very good product, it feels boutique-ee. In the West End market, we have an asset, Arcata, that has had competition sprouting up all around it for the last few years. Again, I mean, the bad news about being in a good location is other people want to be there. And that's another story where we really like our basis and feel like that market will help pull us up over time. In both cases, we've done a good job of holding occupancy. Edina, it would be another submarket where that dynamic is in place. And so if you took those 3 submarkets, West End, Downtown and Edina. Together, it's almost half the supply in the market. So it will affect us. It's -- I don't think it's going to affect us very negatively. It will affect our ability to push rents. But again, we're below the new supply, which I think is a good dynamic with very attractive product. On the -- you want to talk about occupancy?

Yes. On the occupancy side in Minneapolis, the dip in occupancy there is really due to the value add. This is the market where we have 2 of our largest assets going through value-add renovation. So that does increase our vacancy. It was -- that increase in vacancy was 1.5% just in the fourth quarter attributable to value add. And we do see that tapering off a little bit as we get those programs rolling a little bit faster. And our Q1 occupancy is higher because of our lower lease expiration. So we have less units actually in the value-add program. But you're right. Our goal is to balance or to optimize total revenue. And so that is a little bit suboptimal occupancy, but we did see -- as you can see in our supplemental, we did have really good positive rental growth in the twin cities. So some of it was a little bit of trade-off for rate versus occupancy, and a big portion of it was the vacancy from value add.

Okay. And then since they did make it into the same-store portfolio in '19 and not in the supplemental. Can you talk about how your Denver assets are performing? And how they're expected to perform in 2020?

Yes. You want to...

Yes. So we're really pleased with the Denver assets. We have 3 assets there, one which we just acquired Lugano in 2019. And we also internalized the management of West End in 2019. So we now have 3 solid assets that we're managing ourselves, which has been great for our team, team in Denver. And we're really happy with how they're performing. We're seeing really great growth on the renewal side there, which is very positive considering the supply in that market. And in 2020, the -- both the Dylan and West End will be in our same-store portfolio. So you'll start seeing numbers on that region in our first quarter results. But we're expecting to hold study there and get some rent growth in 2020 from all 3 of those assets. Strong on the renewal side, and we are seeing some rent growth on new leases as well.

Okay. And then can you talk a little bit about where in terms of the markets are going to wind up being for you guys? They're going to come in at the sort of high-end or even above the high-end of the same-store revenue guidance for the year? And which ones you expect to sort of be at the lower end?

Yes, Anne, keep going.

Yes, I think for our 2020 guidance, we're really expecting quite a bit of revenue growth in Minneapolis, mostly due to the value add. We should be seeing some better revenue growth out of Omaha. And we'll -- and we expect that Denver will be a strong contributor to -- on the high-end side. On the lower end of the guidance would be our North Dakota markets, where we do continue to see a limited amount of ability to push rents there.

And is redevelopment stripped out of same store? Or is it included in the same store?

It's included in the same store.

Okay. And then lastly for me, Mark, how are you and the Board thinking about new market opportunities, whether it be a market like Phoenix or Dallas or some other market that you could go into? If you sell down the legacy markets over time, how high of a concentration in Denver and the Minnesota markets are you willing to go? And do you need some additional, incremental investment markets in order to balance that out going forward?

Yes, it's a great question. It's something we're spending a lot of time on. And as part of a whole strategy of how we differentiate and how we compete and what it gets the investor to be in different markets, I think we will end up looking into other markets. As I think we've talked about in the past, it will -- they will share the DNA that Mini and Denver have in terms of what we believe to be durable, reasons to live there and high quality of life and innovation-centric economies. So that's work we're doing right now. I mean, I think as it relates to the focus of myself and the team every day, it's really all about operating and continuing to build margin. When we sit around and talk about what could be. We definitely will hone in on a few markets. And directionally, in my mind, which is -- this is me speaking, not the full Board, it should be less markets not more with concentrations in areas where we really feel we can build a competitive advantage and have above-average growth.

Okay. But in the meantime, is there any caps that you guys have put in place in terms of how much any one particular market or how much any 1 or 2 particular markets can really represent in terms of revenue or whatever metric you want to look at just in terms of diversity and concentration risk?

We have not.

Our next question today will come from Barry Oxford of D.A. Davidson.

Looking at the recent sale of Sioux Falls and the cap rate there, if you could kind of -- maybe if you can't give an exact one, talk about it? And then the cap rate that you're currently looking at for deals in the marketplace kind of right now. I guess, Mark, what I'm really kind of getting at is cap rate dilution.

Yes. So the Sioux Falls, Sioux City, we sold on -- we're -- we like to give 0.25 point range, is 5.75% to 6% cap, which we were quite pleased about. We put that in our portfolio at Sioux Falls. In point -- in fact, there were actually 2 portfolios there that were actually in reasonably disparate geographies, Sioux Falls, South Dakota and Sioux City, Iowa. So kind of different markets, but very similar product and what really drew our eye to that sale, as I -- we may have mentioned on the last call was what we saw happen in Topeka, which was a robust bid for a product that we felt had very low growth prospects and very high CapEx needs. So to answer the other half of your question, which is where do we see investing? I mean, we've been really surprised with where some of the assets have priced. It is my belief, and I think you could probably find some math to support this, that the investment community has lowered their overall return expected -- expectations. So large insurance companies, pension funds, who, I think, this time last year may have been underwriting to an unlevered mid-6s have moved that number down to six. And I also think that's a big dial to turn. I also think they've changed their assumptions about their reversion cap rate. And maybe they've gone from 10 basis points for every year they hold of expansion to 5 or they're going to exit flat because I think there's a general perception that we're lower for longer, and they need to get the money out, and you can't win deals right now. It's -- 7% unlevered IRR is your required returns. So that's a long-winded way of saying the cap red spread is probably 150 basis points. I think that masks a little bit the AFFO story or the distributable cash story, which I think is better. So a broker would tell you that you could buy the Sioux Falls portfolio and you could put agency debt on it, and it's going to be $250 a unit of Capex. I mean, that just isn't so. We can't underwrite that way. We don't. So when we look at our hold versus sell, that's a pretty powerful positive for us. And that's before you even talk about growth, which is highly important.

Right, right. Mark, are there other Trammell Crow deals out there that you guys engaged in, like this one? Are there other ones out there? Or look, Barry those are more kind of runoff situations, we'd like to do more, but they're just more runoff.

That was a bit of a one-off. It was -- I mean, there are -- there is an opportunity to do more deals like that, development-type deals. But we look at quality of earnings. We look at risk. In that particular situation, that was a group we know well and have had a lot of dialogue with. It was sort of opportunistic there. They got pretty far down the road with another partner and needed a quick close at the end of the year, and we were able to be there for them. I'm not sure how many, what I would call uni-tranche deals, you'll see us do where we're the full stack like that. We're probably more open to doing the mezz and preferred-type investments, if we can see our way possibly to owning the asset. So it -- we look at them all the time. It's something you can turn the spigot on and get just crushed with volume of opportunities. So we're pretty picky there.

Perfect. No, that makes sense. And last, question. Mark on that option to buy, is that a pre negotiated? Or will that be negotiated at the end?

We have a construct in terms of price, so there's kind of a ceiling and a floor that gets us what we perceive to be at a 25 to 50 basis point premium to today's market cap rate for a new asset. Now having said that, today's market cap rate for a new asset is lower than I think we negotiated because we've seen some pretty stout pricing. So for example, just to give you one anecdote, there was an asset here in the twin cities that just traded last quarter. It was less than a year old, it was barely stabilized. It's in a good location, but certainly not an A+ location in my judgment. And it traded at a 4.25% to an out of town buyer, all the buyers were out of town. So Minneapolis, I think, is seeing more capital than they have historically. It's a good, stable market that's produced long-term top line growth and very consistent occupancy, and that's because people are moving out of Manhattan, because they're a little nervous about rent control in other places, or for whatever reason, there's just a lot of capital. And I'd say more of it's trained on the twin cities and has been true historically.

Our next question will come from John Kim of BMO Capital Markets.

This is Marisa on for John. My first question is on noncontrollable expenses. Can you discuss which markets are contributing to the large increase this year? And off of that, how does this impact the timing of your rise by 5 program?

Yes. So the biggest market that really caught us by surprise, and everyone else, I think, who read our numbers last night, was Rochester. In Rochester, our taxes went up 27% year-over-year, which is quite a bit. And then we had a couple of other markets, in particular, Minneapolis and Omaha, in Lincoln, Nebraska. But -- so we weren't planning. I mean, I think we had high expectations for taxes, and they exceeded our expectations. So how does it affect our rise by 5. It definitely stunts it. I mean, it's going to be hard for us to show meaningful margin growth this year. I mean, we're going to try like hell to do it. And I'd like to report that we did this time next year. But those expenses are hard to overcome. I will say, all the work we've done on rise by five allows us to hold margin as opposed to go backwards. So one part of going forward is not going backwards. We will achieve that.

Got it.

Sorry, go ahead.

Also, I was wondering if you can discuss how much you're spending this year on tech investments and potentially branding initiatives?

This is John Kirchmann. So on the tech initiatives, the things we're really spending on now are more on the additional user fees for using or implementing new technologies. We're not spending a lot of capital at this point. We may do that down the road, and we will communicate that. But right now, it's really the investments just going through our property management expenses as additional user fees. And I think as we discussed in the guidance, that amount in 2020, it's going to increase about $300,000 to $600,000. A lot of that increase is really just what we've already committed to in 2019, and it's just getting the increases from a full year run rate in 2020 versus 7 months of run rate in 2019.

Our next question will come from Ami Probandt of BTIG.

I'd like to return to occupancy for just a moment. With the kitchen and bath renovations starting in Omaha, should we expect to see a similar occupancy dip to what we saw in Minneapolis?

Yes, we will have some additional vacancy loss in Omaha. But we still -- given the off-line units that we had last year and some of the dip we had in occupancy, and we've now recovered there up to 94.5%, that's where we sit today. I wouldn't say it's going to be any worse than what we experienced in 2019 in that market.

Okay. And then in the past, you've talked about efforts to increase occupancy through reducing days vacant following a lease termination. Could you discuss the progress on that? And also how you expect overall occupancy in your portfolio to trend in 2020?

Yes. So our goal is to really start to kind of minimize the delta between our top -- our high occupancy and low occupancy, the volatility there. And really, are -- we're trying to run the portfolio at 95% or right around there, which we believe gives us good pricing power and really hits right where the market is across the portfolio. We have made progress on reducing the number of days vacant, both -- 2 components of that: one, they are being turned faster. Our expectation is that all of our turns are done within 3 to 5 days. And second, we have a much larger focus on leasing. Particularly as last year, we enhanced our revenue management platform, and that is getting -- we have a lot of focus on getting the units out the door at the right price and have had some success in that.

Okay. So should we expect to see continued benefit through maybe the first half of 2020? Or is this something that's ongoing through the end of 2020 into 2021?

I think it's ongoing. I mean, we can't ever really -- our focus on reducing that -- the number of days vacant. I mean, you -- it does drive a lot of revenue and really can create some efficiencies on-site when they get the process down to move those units quickly.

Absolutely. And then just one quick one on the repair and maintenance. Is any of that R&M increase due to the kitchen and bath renos? Or is that all capitalized?

That's all being capitalized. As I mentioned, some of the increase in the fourth quarter was due to roof repairs that we believed at the time we engaged on those roof repairs would be considered CapEx items. So as John noted, our CapEx came in a little bit lower than we had guided to, but our repairs and maintenance in the fourth quarter did have a $230,000 hit of -- that we won't see again.

[Operator Instructions]. Our next question will come from Buck Horne of Raymond James.

Mark, I just want to go back to the Rochester tax increase, if you could for a second. How do you go through the appeals process with that municipality? Or whether you're looking at Minneapolis or Lincoln? Or wherever you're getting these outsized increases, how do you think the appeals process could play out? Did the entire market get that kind of reassess or similar magnitude reassessment? Was there something in particular about your property that was outsized? Or just trying to understand if there's any chance that what you're modeling here is kind of the worst-case scenario and you can possibly get some recovery later this year.

Yes, Buck, everyone who's around the table here is jumping to answer this question because we've all talked so much about it. But I'll start. The answer to the question is, I think it's a lot of things. I mean, one, there is a new assessor in that jurisdiction in Rochester. And they have a house view, if you will, a government view that multifamily hasn't been paying their fair share. They have the benefit of a lot of transactions that show where values are. They've been somewhat inconsistent. So if you look over the last couple of years, 2 years ago, our taxes went up 10%. Last year, our taxes up -- went up 1%. So I mean, we were expecting tax increases. I would even say we could have expected increases to come -- they start really writing up the assets, sort of 1/3 at a time and it spilled through that way. What they did, which I think is unusual and we are absolutely going to appeal, is they marked the whole thing up 25%, 28%, I think, with no change in mill rate or fees or anything like that. So it's just a straight year-over-year increase that is close to $1 million. I mean, it's our largest expense line in our P&L. So we will appeal. I mean, our appeals from the last two years are still outstanding. So these things do take time. The numbers you have from us are what we believe to be is the worst case, which is what we've been assessed at and if we can do better on appeal, that will unfold a year - two years plus down the road. So I think we'll have some success there, but it's really impossible to say. And if you look at it from their perspective, they have limited abilities to pick up revenue, and it's more attractive to tax a multi owner than a homeowner because we don't vote. But I think this thematically, this is something that's happening across all markets and it ebbs and flows. And again, we like Rochester, and we think they've done a great job in making it a more dynamic place to live. A lot of their efforts are around making this a place that can compete with Back Bay or San Diego, because what they have there in terms of the facility. The Mayo is truly incredible. And like everyone else in the world, they're trying to find the best talent and Rochester, Minnesota in February just doesn't feel like San Diego. So that's a hard thing to compete with what they're doing to make it more dynamic, I think, is effective, we support that. We'd certainly like to do it in a more measured way. And that's the discussion we'll be having.

I got you. Okay, that's really helpful. And looking at the value-add program, the investments for this year, do you guys have a target or underwritten return on investment for this year's spend? Is it any different than what you've achieved on previous value-add spending? Or how do you quantify either the incremental rents and the incremental ROI that you're getting there?

Yes. So we really have two categories of value add projects. One would be kind of amenity upgrades or repositioning of assets. And on those, we're looking to get a 10-plus percent return. Now we think that those investments have a longer life, right? So that is putting in the new clubhouse, rebranding, exterior work. And that return, that 10-plus percent return, really drives what the second half of it is the unit renovations. And there, we're really looking for 15% to 20%. I think our fourth quarter return with a $154 premium and about $10,500 of spend is just over 17%. I think that is what you can expect from us going forward with respect to the unit turns. And then there is some variation as we reposition the assets to help us get that premium on the unit renovations.

Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Mark Decker for any closing remarks.

Thanks, Allison. And thanks, everyone, for your time and interest in our company today. We look forward to talking to you after the first quarter. And if you're headed to the Raymond James Institutional Investor Conference in March, we'd love to see you there.

The conference has now concluded. We thank you for attending today's presentation, and you may now disconnect your line.