Good morning, and welcome to the Centerspace Second Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mark Decker, Chief Executive Officer. Please go ahead.

Thanks. Good morning, everyone. Centerspace's Form 10-Q for the quarter ending June 30, 2021 was filed with the SEC yesterday after the market closed. Additionally, our earnings release and supplemental disclosure package have been posted to our website at centerspacehomes.com and filed on Form 8-K. During the course of today's call, it's important to note that our remarks will include our business outlook and other forward-looking statements that are based on management's current views and assumptions. As a result, we cannot guarantee that any forward-looking statement will materialize, and you are cautioned not to place undue reliance on these forward-looking statements. Please refer to our earnings release for reconciliations of any non-GAAP information, which may be discussed on today's call. With me this morning is Anne Olson, our Chief Operating Officer; and John Kirchmann, our Chief Financial Officer. We're fortunate today to be in the housing business, reporting these results that were unimaginable 12 months ago. I want to start by extending my thanks and appreciation to our community and support teams that have displayed incredible resilience, creativity and thoughtfulness since 2020 began. In addition to being in a housing market that turned on a dime, our teams have been hard at work as we make considerable investments in our business, starting late last year with the renaming and more heavily this year as we move from our legacy property management system to a far more enabling and modernized system that will allow us to get to the last phase of our Rise By 5 campaign. So in every respect, the company that's reporting today is measurably better than the one that reported a year ago or even in June. The second quarter exceeded our own expectations as the recovery outstripped our forecast, leading to better rent growth, same-store NOI…

Of course. Thank you, Mark, and good morning. The trends that we saw in Q1 accelerated in the second quarter, providing us with great operating results and strong tailwinds heading into Q3. Our same-store portfolio realized a 1.2% increase in NOI over the second quarter of 2020 driven by a 3.2% increase in revenue over the same period. Our year-to-date revenues are up 1.9% over the same period in 2020, driving a 1.7% increase in year-to-date NOI. Our revenue performance is all about our lease rates as our weighted average occupancy in the second quarter was 94.9% and has stayed consistently between 94.4% and 95.3% for the past 6 quarters. Our revenue per unit, which is the result of occupied rent times occupancy, continues to climb. Q2 saw rise to $1,175, which is $50 more than this time last year, and $77 more than this time in 2019, a 7% increase over 2 years. Effective move-in rents for the second quarter in our same-store portfolio were 10% higher than prior lease, and renewal rates increased 5.6% for a blended rate increase in Q2 of 7.5%. Our leaders have been in our secondary markets. Our Other Mountain West portfolio, consisting of Rapid City, South Dakota and Billings, Montana, realized a 14% increase in revenues over Q2 2020, while also achieving a decrease in expenses for a 26% increase in NOI when comparing the second quarter with the same period last year. While our secondary markets have seen significant gains, there are some lingering negative effects of the pandemic in our portfolio, specifically across Minnesota, where the eviction moratorium is still in place with limited exceptions. While other markets and states have returned to pre-pandemic collections levels, Minnesota is an outlier. Our forecast does anticipate this improving as policymakers work through the…

Thank you, Anne. Last night, we reported core FFO for the quarter ending June 30, 2021, of $0.98 per share, an increase of $0.07 or 7.7% from the second quarter of 2020. The increase is attributed primarily to higher NOI, offset by increased interest expense and a higher share count. Looking at our general and administrative expenses. For the 6 months ended June 30, 2021, G&A expenses increased $1.1 million or 16% to $7.7 million from the same period of the prior year. The increase is primarily attributed to increases of $500,000 in long-term performance-based compensation and $500,000 in nonrecurring technology implementation initiatives. The increase in long-term incentive compensation is driven by the timing of the performance grants from the prior year occurring in May of 2020 versus January 2021 for the current year as well as the 2020 plan utilizing stock options for performance-based compensation, which reduced the accounting cost of the 2020 grants by approximately 30%. Property management expenses of $3.9 million increased 34% or $1 million compared to $2.9 million for the same period in the prior year. The increase comes from $200,000 of recurring technology costs related to newly implemented initiatives and $300,000 of compensation costs as a result of filling positions that had been left open since 2020 as well as higher health care costs in 2021. In addition, year-to-date property management expense includes nonrecurring tech implementation costs of $400,000. Moving to capital expenditures, full year same-store CapEx spend is expected to be $875 to $925 per unit. Our same-store CapEx forecast has been reduced from earlier guidance due to the impact of dispositions. During the second quarter, we fully utilized our ATM, issuing 731,000 common shares for net proceeds of $55 million. These proceeds were used to fund a portion of the Union Pointe acquisition and draws under our mezzanine lending program as well as anticipated transaction costs, prepayment fees and capital related to the KMS transaction. In the course of normal business, we will file for a new ATM later this month. In conjunction with our earnings release, we revised our financial outlook for 2021, which is presented in S-16 of the supplemental. With strong quarterly results fueled by accelerated rent growth, we increased our full year core FFO per share midpoint by 7% to $3.86. We have also increased our full year guidance on same-store revenues and NOI growth. Same-store expense growth has increased from prior guidance due to the impact of dispositions. The year has been positive with strong year-to-date results, improving fundamentals and an improved financial outlook for the rest of the year. I would like to thank our dedicated team for their work to make better every day for our residents. And with that, I will turn it back over to the operator for questions.

[Operator Instructions] Our first question comes from John Kim with BMO Capital Markets.

Anne in your prepared remarks, you mentioned, I think 13% increase in new lease rates in July and Denver will be leading the charge. But I was wondering what other markets are either outperforming or underperforming that average for you?

Yes. So that was just the Denver rate, which is, I'd say, right in the kind of main of what the average is for July overall for our new lease rates. We continue to see pretty dramatic outperformance in the Billings market and Rapid City market. But overall, our new lease rates, in July, really came in right in line with Denver.

And how do you see occupancy trending in the third quarter? I think you mentioned 41% of your portfolio has leases expiring, and you had, I think, flat occupancy in the second quarter. How do you see that changing over the next couple of months?

Yes. In line with our historical performance, we think that occupancy will dip a little bit as we push those new lease rates and try to optimize the revenue. 41% is a pretty big chunk of lease expirations in this quarter. But as I noted, we have been able to keep that occupancy within a really tight range with our low end being 94.3%, 94.4 over the last 6 quarters. So we're optimistic that occupancy is going to stay strong. And really, our goal is to optimize the revenue and take advantage of those growing new lease rates.

Okay. And then my final question is, Mark, I think you mentioned you were -- you lost out on some acquisition opportunities in some of your markets. Given your cost of capital continues to improve, your stock price is up 21% over the last month. Does it provide more ability to execute or be more aggressive on acquisitions? And should we anticipate increased activity in the second half of the year?

Certainly, this recent run has improved the cost of capital. So that does makes us a little more competitive. I mean, we are -- I would say we're very competitive. But where we -- where the world sort of ends for us is when it stops being accretive to the overall. So these mathematics will help a little bit for sure. and we'll be disciplined about that.

The next question is from Gaurav Mehta with National Securities.

I was hoping if you could provide some more color on your TMS acquisition, how that came about. And what did you like about that acquisition? And maybe provide some color on the pricing and the valuation of that acquisition?

Gaurav. So that acquisition really came out of about 2 years of dialogue. So I mean, we're always working dialogues like this. And as I joked to our Board, we're more like professional golfers than baseball players, meaning, we lose most of the time. And so this was a situation where we had really a contributor. They're not really a seller who was looking for a solution to provide liquidity and tax protection. So I mean, he had several asks for him and as partners that we were able to meet I would say it's more often the case that a seller just wants cash. They can understand cash and they can understand tax bills. So to have a dialogue like this kind of pull all the way through to a close, in my judgment, you have to have a very discerning seller who's really willing to have a 2-way relative value discussion. So he's taking our equity. So as soon as we agree on what his price is, then we have to agree on what our price is that happened in December. Candidly, when we had a very different view of the world as did the seller. And so we arrived at price based on a relative 2-way discussion on what our overall company was worthwhile we thought his was worth what the tax protection was worth. So a lot of considerations to kind of get to the finish line. But it was also very important for him to have a good place for his team to land. This gentleman has been running this business for 40 years, so this is his life's work. And it was important to him to have a steward to carry that forward for the team who wanted to stick around where we've -- and we've spent a lot of time and energy making that happen. So really, it was about the people. It was about accommodating his partners. In some cases, their third gen partners. They've been LPs for 40 years. So we're now talking to the original partners grandchild. So I mean, a lot goes into it in any transaction, but there's a fair amount of complexity here and a lot of sophistication, I'd say, on the seller side. Because really, the pitch is, hey, we're going to -- we'll take it from here. We'll run it from here. You're going to participate in the upside. There were a number of things that they, I think, see that we're doing that they agree will be helpful revenue management a number of the technology investments we've made and operating practices. So I guess I'll stop there unless you have more questions about it. But long discussion, we always have these going. They usually don't work for a variety of reasons, but very pleased to be close to the finish line with this one. It's really a big win for us and for the KMS team and partners.

Great. No, that's very helpful color. Second question on your secondary and tertiary market. I was hoping if you could provide some color on what you're seeing in the transaction market there, maybe some handle on the cap rates that you're seeing in those markets?

Yes. I mean, the issue with those markets is there's just not a ton of transactions. And when there are, they may not be relevant. So if a 5 collection in Bismarck sells, I wouldn't say that sets market. But we haven't seen much. I mean, what we have seen is quite aggressive. So as we often talk about, if the government is your staple and they lend on a dollar of cash flow equally no matter where, that's quite powerful. I mean the most recent real data point we saw for a secondary market, outside of anecdotal, what was our Rochester sale, where we sold sub-5 on our trailing 12 sub-5 cap rate for reasonably old assets.

The next question is from Rob Stevenson with Janney.

Yes. Mark, I mean, what is -- or what is the Minneapolis NOI exposure go to post closing of the KMS transaction and you plan on selling some assets in Minnesota or in Minneapolis to reduce that?

I'll go -- bit will go to about 35% for the Twin Cities and I think we'll be probably tipping right around 50% for Minnesota as a whole when you add say St. Cloud and Rochester. And the answer to the question of, will -- I mean, listen, we'll always consider capital portfolio sales. But candidly, -- We really like the portfolio we have in the Twin Cities, and we think it represents a pretty strong opportunity to push cash flow growth. So I would say, for the time being, you shouldn't expect to see us actively selling things in Minneapolis, unless someone wanders into our office with some really undisciplined capital, in which case, we've got to buy it now price for everything.

Okay. And then the $40 million of rehabs on the KMS stuff implies something like $15,000 a unit. What is your typical kitchen and bath remodel running you these days given current construction costs trying to get a feel for how much beyond the sort of normal redevelopment scope these properties either need or warrant at this point?

Yes. So that dollar -- I would call those dollars not value-add dollars. So I would call that deferred capital or general property improvement. I think we believe that we will be able to get to the top of market for those specific types of homes based on having really gotten everything to tip top, but the value add would kind of be a gear past that, which we haven't really talked about. There is a lot of value-add pipeline, I think, embedded in that portfolio. but you should think of that $40 million is kind of keeping up with the Joneses capital.

Is there a reason why you wouldn't do it at the same time that you'd come back and do that stuff later on versus just knocking it out now, especially given the capital position you have, unless you do another big acquisition?

Yes. Short answer is we may. I mean, we've given ourselves 3 years to put that capital out. So I mean there's nothing critical fire life safety. I mean, these properties are well run. They've been run by a private owner who probably refis every 7 years, and that's kind of when they've gotten capital. So there is some opportunity, I think, just to bring capital up to now. But Anne do you want to...

Yes. So the way we're going to approach the value add and the spend, which I'd say typically, we're looking at 10,000 to 12,000 a unit on a full unit renovation here in Minneapolis. But the way we'll approach that is we really want to take over operations, get their communities on to our platform, and then really see where the rents are. And then we would start kind of looking to underwrite. But if we take their in-place rents today and try to underwrite value add, we may not be considering the true value of what the market rent is for those once it's on our platform, and we've kind of exhausted all the other revenue opportunities. And that does take some time to get us through the lease role. And during that time, we'll be looking at those value-add renovations. And as Mark indicated, because we have a few years to deploy that $40 million, some of it may happen concurrently. But the things that will happen in the first year will be really just setting the stage for the potential of value add in the future.

Yes. Rob, I mean, just to expand briefly, we really look at this as like IRT circa 2016. And that's the real opportunity is just to kind of bring everything forward. So in that sense, it feels very familiar to us and being able to buy something that makes sense on day 1 and not have to push a bunch of initiatives that may or may not be the best thing given a little bit of time in the saddle feels really good to us.

Is there anything quirky here, given some of the age of the communities in terms of the expenses, either in terms of heat being included or the inability to submeter for water, et cetera, or use Robs, et cetera, in the locations that they're in?

No.

No.

Okay. And then last one for me. Anne, when was the depth of new leasing for you last year? In other words, max concessions, lowest effective rent. So curious as to what your year-over-year comps are easier this year, what month are easier this year, and then when they start to get more difficult for you?

Yes. I think that we don't have that exactly in front of us, but we -- July really was probably our toughest month last year with respect to concessions. We were holding our renewals flat. We were not -- we had very, very low traffic and saw some pretty big declines in some of our new lease rates. So I think it was July. It got a little bit better in August. We started pushing renewals and seeing some stabilization in the rents come September.

Next question is from Daniel Santos with Piper Sandler.

So my first one, maybe, Anne, this is for you. It's about the Delta variant, which is on everyone's mind. Obviously, you guys probably aren't as affected as say office. But are you seeing any impact on the ground relative to your properties or the market economies? And I guess, if you zoom out a bit, are the local sort of state governments reacting differently. They were sort of -- in the last year, they were slow to respond. So I'm just curious to see if that's still the same this year?

Yes. We just actually provided our team with an update this morning on the Delta variant. So good timing. We haven't seen any response from any of our state or local governments. But beyond just kind of reiterating what the new CDC guidance is about wearing masks in public places where there is high transmission rates. We don't operate any place that right now has high transmission rates or a high number of cases on the Delta variant. So we're watching that closely. We -- one thing we're sure of after last year is that we're prepared to be very nimble. I mean, we could put in place -- put back in place any of the protocols or procedures needed at any of our assets. But to date, we're still operating in the areas where the governments aren't responding yet, and we haven't seen high transmission rates.

Okay. That's helpful. And then, I guess, more specifically, you mentioned the remaining eviction moratoriums and how they haven't been lifted yet in Minnesota. Is your sense that when they are lifted, the tenant -- the few tenants that are sort of behind in rent going to try to catch up and stay in the portfolio? I sort of ask because if you think about coastal markets, it's a lot harder to catch up on a few months of missed rent, if your rent is $3,000 or $4,000 versus the $1,400 in your average portfolio?

Yes. I think that we're going to have a little bit of a mixture as it rolls off. So we are starting to see some traction with the rent help programs here in Minnesota. The best outcome for us is that the those -- is that the residents who are behind are able to get assistance and stay and then continue to pay going forward to the extent that their income has stabilized and they can't afford it. But -- and I think that will be the case for some. And then -- and it's probably 50-50 and the other 50% will probably, once we're able to move on and find other housing that's suitable to their income and/or if they pocket the rent that they didn't pay for a year and take it and do something else. But we've been encouraged and we're optimistic about the rent help programs here, both in Minnesota and in some of our other markets where they have launched kind of ways for people to stay in. That's the best solution for us as an operator is to actually collect the rent and help the residents stay in place if, in fact, they're able to make the rent payments going forward.

Okay. That's helpful. One last one for me, if I can. When you think about potential acquisitions going forward, is your sense that you're going to target maybe B or B- assets that you'll kind of improve to a B+, or are you seeing opportunities to maybe buy, we'll call them, sort of aging product that just might pencil better for the second owner?

Yes. I mean, Daniel, the answer honestly is we're looking for the best relative return for the asset that we believe has durable pricing power in a submarket. And I mean, there's more than one of those in submarkets. But where we found ourselves -- I mean, it's been interesting because there's been just so much compression and B has really been working and funds that are oriented towards value-add, have a lot of dollars and also a lot more knobs they can turn in their Excel models. Where we've historically found, in our judgment, the best relative value is with a pre-stabilized deal or a new lease, Union Pointe would be a good example, newly stabilized deal. We're typically missing the value add by 4% to 8% is where our underwriting because, again, our bias is to get into the asset, live in it for a little bit and then come up with a good business plan from there. The winning bidder is not doing that. They're going to come up with their business plan in advance, and they're going to go right away. And I'm not faulting them. That's just not how -- that's risk we've been unwilling to take so far. I don't see our risk appetite changing a lot there.

The next question is from Buck Horne with Raymond James.

I appreciate the discussion. Curious just on the thoughts around Nashville at this point, just given the capital surging into that market area and the compression we've seen in cap rates? And is anything penciling is potentially feasible in that market near term? And do you start to shift your focus into other geographies or other types of price points that might be cash flow accretive?

Yes. I would say, I mean, on the bright side, there's been more product actually available in Nashville over the last 3 to 4 months. It was really slow in the beginning of the year for a couple of reasons, a lot around tax, understanding what the taxes were going to be going forward. But listen, we're -- we've been close on a bunch of things. And frankly, we have some shareholders who say, well, don't and some shareholders say, push forward. Listen, it was a strategic decision. We don't generally change strategy based on a few months of data, but we are -- and it's also the case that yields across the markets. It's not like Nashville is really hot and everywhere else is awesome, and we're just avoiding great deals in other markets. It is the case that there is an enormous amount of capital chasing multi and pricing has really come in. So the last deal that I really liked in many -- or I should say, we really liked and many sold at a sub-4 cap rate similar kind of 10-year IRRs to what we're seeing in Nashville. So the going in cap rate is 1 piece of data. And I would say the market is generally pretty efficient at pricing growth in those markets. And we consider that when we're looking at assets and markets and submarkets. In short we'd love to do something in Nashville and if we can find something that meets our returns, we'll do it.

Okay. But speaking of kind of long-term growth, certainly, the back-to-office shift seems to have slowed a little bit recently, but also just a lot of survey work seems to indicate a lot of workers enjoy remote working, and there's certainly been a huge population shift into the secondary markets. You're seeing that, I think, obviously, in Billings at the moment and a few other places. Does that shift in that secular change in how people want to live, give you some pause around maybe reallocating capital to your secondary markets or finding assets in Billings as an example to kind of change your portfolio mix?

Yes. I mean listen, if something comes up in one of our secondary markets, we generally look at it. So you should know that we're looking at anything that kind of comes up where we're active. The thing that we love about Billings and Rapid City and I'll say the whole Mountain West portfolio, which is now about 30% of our NOI, is that like the Southeast, they're catching a lot of migration. And obviously, Rapid City and Billings are much smaller metros. So a little bit of in-migration goes a long way. What we haven't seen with the same amount of robustness as Denver is in housing pricing move and new job creation, and that's really what is the long-term driver in our judgment of being in a great multifamily market or apartment market. So we have to balance all those things together.

[Operator Instructions] The next question is from Amanda Sweitzer with Baird.

I had a few questions on some of the moving pieces within your guidance. Kind of to start, can you provide an update on what you're assuming for the KMS acquisition and guidance in terms of both pricing and timing? I assume that cap rate assumption has increased today just given the broader fundamental strength you've seen.

Yes. I mean the cap rates that we've generally talked about for KMS is plus or minus 5% kind of going in 5% and after capital. I mean, candidly, the NOI we underwrote and agreed to was in February. They are ahead of their budgets, their budgets and our underwriting aren't the same thing. But I would say one of the things we believe was embedded in that portfolio was a reasonable loss to lease, that's grown. I mean, we haven't gotten that scientific about it. We're really focused on integrating the team will be picking up about 130 team members as part of that. And so our focus really has been on getting that team or getting ourselves prepared to onboard that team. We have a pretty significant integration of Yardi that has to go right alongside that, which is a lot of complexity that they don't let me in those meetings because they're very detailed. But there's a lot of work going on with that. I mean what we know is it's no worse than we expected. It's probably better. And frankly, for now, that's all we need to know.

Got it. So in terms of timing assumed in your guidance, for that deal, though, is it fair to assume midway through the third quarter or what's embedded in it?

September 1 is our scheduled close date. I mean, at this point, that's -- there's a lot going to that. We're on track for that date.

Okay. That's helpful. And then, what blended lease rates are you assuming in the second half of the year in guidance? And where are your renewal rates going out today?

Anne, can you talk about that?

Yes. Our renewal rates today in July were 5.1 -- sorry, 5.1%. So that's where our renewals are going out today. And then, John, on the forecast side for guidance, what are we assuming there? A little bit less than that, I think.

Well, Amanda, the way we forecast our rents is we actually use our rent roll and the loss to lease that's embedded in that rent roll. That's 8%, I think, Anne, right? Correct me if I'm wrong here.

Right. So last lease [indiscernible].

8% in July. So what we would have done the way we forecasted is we load those market rents in by every unit. And then the rent growth goals we're using into the future vary by region. But they're not substantial. The real driver of the forecast is that loss to lease. So it's the 10% to 13% new lease rates that we've been getting over the last few months.

Okay. That's helpful. And Anne on that renewal rate increase that you're talking about, was that renewal rates effective in July? I guess I was asking where rate increases are going out today for future period?

That those are the rates that were effective in July. So with respect to renewals, those would have been priced 60 to 90 days in advance of that, but that is what went effective on the July expirations.

Got it. And then, last one on guidance. What was the impact of those Rochester distributions on your same-store NOI growth range? I heard your commentary, John, on the expense growth impact.

Yes. So the way I would look at the Rochester guidance, we actually present in our guidance the amount of the sold NOI, the $1.2 million represented basically 4.5 months of 2021 NOI that we had in our books before we sold it. So extrapolating that out, that would be a fair representation of what came out of the NOI. We don't know exactly what came out of the NOI at the point of time because that's not how we measure it, right? So the forecast has been updated. But that would be a reasonable assumption to use. Is that helpful, Amanda?

I can extrapolate from the $1.2 million. And then final question for me. Just first in cloud during the quarter, you did see a larger occupancy decline in that market. Was that in response to you strategically pushing rates, or were there other dynamics that play in the market that impacted occupancy?

Yes. So it's a little bit of value-add work going on in the St. Cloud market as well. So we have a little bit of value-add vacancy there as we kick off some value-add projects. And then really, it is the pushing of the rates in that market. So -- and that is a trend we typically see here coming into the third quarter.

The next question is from Barry Oxford with Colliers.

Mark, when you think, not necessarily about your portfolio, but when you think about the markets in relation to the moratorium and that burning off, do vacancy rates have to kind of creep up or not necessarily because you think the rent help programs will come in to that? But if vacancy rates are going to be climbing in the future because of this, how are you guys figuring that out into your software system as far as rental increases, maybe 2, 3 months from now?

Yes. I think we've been watching that really pretty closely. And one of the ways that we figured that in is the individuals who, for example, haven't paid for 18 months, they're on month-to-month leases. So -- and we have -- we feel really good about our percentage of month-to-month leases as compared to the whole. So that is one way we're kind of managing it and monitoring it. We do not -- our collections rates have been strong. And while we do have at each site a few people that we would like to move along if the eviction moratorium were to burn off, I don't think it's anything dramatic enough to really impact our overall rates. But it is yet to be seen how much the rent help will give us assistance and help those people stay in place. But there -- at this point, all of those residents are on month-to-month leases, and we're watching that number closely as a percentage of the whole and making sure that we're managing that. Everyone on a month-to-month lease could leave at the end of the month. And so we factor that in when we look at exposure.

Yes. I'll just make a macro comment, Barry, I mean, we're not over housed. So I mean, I think it's hard to imagine, vacancy materially moving down, especially at our price point, which we're plus or minus $1,200, $1,300. I mean, the most amount of supply is $400 to $600 north of that in most markets.

Okay. So you wouldn't foresee something that would cause you to kind of back off of your rent assumptions?

No.

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

Thanks, Gary, and thanks, everybody, for your time and interest in Centerspace, and we look forward to talking to you next quarter.

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